Implementation Of ALM Policies In A Bank
ALM, or challenging asset/liability management refers to efforts by a bank’s board and senior management team to carefully balance the bank’s current and long-term potential earnings with the need to maintain adequate liquidity and appropriate interest rate risk exposures. Each bank has a distinct strategy, consumer base, product selection, funding distribution, asset mix, and risk profile: These differences require that assessments of risk exposures and risk management practices be customized to be effective since each bank has their own specific risks and activities. Regulators assess risks and risk management activities in four broad categories, but only two components relate to ALM: Board and Senior Management Oversight and Policies, Procedures, and Risk Limits.
Effective board oversight should include the following: Understanding risks where bank directors demonstrates that they clearly understand the risks that are inherent in the institution’s ongoing activities, in addition to questioning senior management about risks and risk management costs that are presented by new activities and consider the risk/reward trade-offs; providing appropriate guidance regarding to risk tolerance; monitoring exposures and reporting them on a timely basis; and hire managers who possess the expertise necessary or train individuals to effectively administer risk management activities. Looking at senior management activities, they should include the following: Implementing ALM policies established by the board; developing risk monitoring and reporting tools; reporting risk exposures to the board; and attracting and developing personnel. A sound policy directive for the bank’s various activities and risk exposures is an effective tool that the board and senior management can provide to their staff. With sound policies, it allows the board to communicate to frontline and senior personnel its expectations regarding risk tolerance, desirable and undesirable activities, internal control and audit, and risk measurement.
When regulators examine and evaluate ALM policies, they look to see that following issues are appropriately addressed: The policy should state the bank’s objectives for ALM and provide a well-articulated strategy for managing the risks associated with balance-sheet accounts; setting appropriate aggregate risk limits for interest rate and liquidity risk exposures; provide clear lines of authority, responsibility, and accountability regarding risk management activities; precisely describe the types of activities that an institution may conduct. A leading ALM risk management practice is to utilize external resources for educating directors to gain enough understanding of balance-sheet risk management concepts.
Another approach that other banks have used is to include at least one director who possesses a great understanding of balance-sheet management concepts. Together, these improve the boards’ abilities to oversee balance-sheet risk exposures. Another leading practice is to identify risks and update policies before implementing new products or activities. Doing so will prevent unexpected risks and additional post-implementation expenses. In conclusion, regulators assess risks and risk management activities that relate to ALM by looking at the board and senior management, and policies, procedures, and risk limits. An effective board should understand risks, provide appropriate guidance, monitor exposures, and make personnel decisions/delegate. An effective senior management should implement ALM policies, develop risk monitoring and reporting tools, report risk exposures to the board, and attract and develop personnel.
Finally, a sound policy directive will allow the board to communicate to frontline and senior personnel its expectations on risk tolerance, desirable and undesirable activities, internal control and audit, and risk measurement.