Asset Liability Management
Key Concept of Asset Liability Management
- Balance Sheet Risk
- Liquidity Risk
- Interest Rate Risk
- Capital Adequacy
Balance Sheet Risk
Balance sheet risk can be categorized into two major types of significant risks- liquidity risk and interest rate risk. Changes in market liquidity and/or interest rates expose banks/ business to the risk of loss, which may, in extreme cases, threaten the survival of institution.
The risk that bank or business will be unable to meet it's commitment as they fall due leading to bankruptcy or rise in funding cost. Banks traditionally use the statutory liquidity reserve and their borrowing capacity in the volatile inter-bank money market as the source of liquidity.
Interest Rate Risk
Interest rate risk is the exposure of a bank's financial condition to adverse movements in interest rates. Accepting this risk is a normal part of banking and can be an important source of profitability and shareholder value. However, excessive interest rate risk can pose a significant threat to a bank's earnings and capital base. Changes in interest rates affect a bank's earnings by changing its net interest income and the level of other interest-sensitive income and operating expenses. Changes in interest rates also affect the underlying value of the bank's assets, liabilities and off-balance sheet instruments because the present value of future cash flows (and in some cases, the cash flows themselves) change when interest rates change. Accordingly, an effective risk management process that maintains interest rate risk within prudent levels is essential to the safety and soundness of banks.
The need to adopt the best international practices given in the pretext of globalization of economies and businesses is a must as you are aware of “Basel Committee on Banking Supervision” and the emphasis on maintaining the Capital Adequacy commensurate to exposure or risk on balance sheet. The new “Basel Capital Accord” stipulates that “Banks must hold capital commensurate with the level of interest rate risk they undertake”.
As mentioned earlier, changes in interest rates expose banks to the risk of loss, which may, in extreme cases, threaten the survival of the institution. In addition to adequate systems and controls, capital has an important role to play in mitigating and cushioning this risk. As part of sound management, banks 21 Bangladesh Bank Focus Group translate the level of interest rate risk they undertake, whether as part of their trading or non-trading activities, into their overall evaluation of capital adequacy, although there is no general agreement on the methodologies to be used in this process. In cases where banks undertake significant interest rate risk in the course of their business strategy, a substantial amount of capital should be allocated specifically to support this risk.
Policy has been formed in the light of instructions of Bangladesh Bank to manage the Asset Liability Risks and accordingly a Manual has been compiled. ALM Organization has been set up. ALCO meets monthly. Treasury Manual has also been prepared for Janata Bank Limited.