Tools and Techniques
TOOLS OF ALM
Techniques for assessing asset-liability risk includes
. These facilitated techniques of managing gaps and matching duration of assets and liabilities. Both approaches worked well if assets and liabilitiescomprised fixed cash flows. But cases of callable debts, home loans andmortgages which included options of prepayment and floating rates, posedproblems that gap analysis could not address. Duration analysis could addressthese in theory, but implementing sufficiently sophisticated duration measureswas problematic. Accordingly, banks and insurance companies started using
.Under this technique assumptions were made on various conditions, for example: -
Several interest rate scenarios were specified for the next 5 or 10 years. These specified conditions like declining rates, rising rates, a gradualdecrease in rates followed by a sudden rise, etc. Ten or twenty scenarioscould be specified in all.
Assumptions were made about the performance of assets and liabilitiesunder each scenario. They included prepayment rates on mortgages orsurrender rates on insurance products.
Assumptions were also made about the firm's performance-the rates atwhich new business would be acquired for various products, demand for theproduct etc.
Market conditions and economic factors like inflation rates and industrialcycles were also included.
Quantitative analysis can assists in determining the level of exposure. Examinersshould perform this analysis as a part of each exam. Ratios and trends are thefocus of quantitative analysis. The following ratios are used to assists theexaminers to examine the ALM position.
Net Loans/ Total Assets :
This ratio measures the percentage of totalassets that are invested in loan portfolio. Management should haveestablished a maximum goal ratio to avoid liquidity problem.