Asset liability management or ALM, is a way of managing the risk that can be caused from changes in the relationship between assets and liabilities. ALM allows a financial firm, or other company to manage the balance sheets properly so that they can keep a mix of loans and deposits that are in line with the firm's aims for long-term growth and risk management. Below are some of the facts about ALM and it's advantages and disadvantages, or pros and cons.
Reasons for ALM
1. Control three types of financial risk: Interest rate risk, credit risk (the likelihood of default), and liquidity risk, which occurs if a given security or asset cannot be traded fast enough in the market to stop a loss or make an estimated profit.
2. Asset liability management now covers other risk as well, like foreign exchange risks and operational risks (including such areas as fraud and legal risks, as well as physical or environmental risks). Such as if a company was to invest in public sector infrastructure, but then the weather prevented the work being carried out in a timely manner.
Advantages of ALM
1. ALM can help protect a financial institution or corporation against many financial and nonfinancial risks.
2. The process of identifying risks lets businesses be ready to deal with them in the simplest and least expensive way.
3. ALM ensures that a company's capital and assets are used in the most efficient way.
4. ALM can be used as a strategic and business tool to improve earnings. Sometimes this can give a firm a welcome boost.
5. ALM also makes it easier and less stressful for a firm to invest in public sector infrastructure.
Disadvantages of ALM
1. ALM is only as good as the people on the ALM committee and the procedures that they follow.
2. ALM can turn out to be expensive due to the time needed from employees and the invest needed for management tools such as IT and techniques like hedging.
What to Do
1. Set up an ALM committee to oversee the process.
2. Give the committee the tools and techniques for measuring and managing rate, credit, and funding risk. This basically means a good computer system that makes it easy to keep track of funding sources and credit exposures.
3. Get a managerial accounting system that can control the information put into the computer system.
4. It's not a good idea to try and cut costs with less investing in tools for management or personnel.
In the end the pros and cons of ALM have to be weighed against each other just like they do for anything else. It can be good or bad, depending on the client and their needs. But if you are a large firm or institution, you might find that such a program is the right choice for you.
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Candace Hubbard is a freelance writer who has made career writing about business and financial matters, including asset liability management and companies investing in public sector infrastructure.
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