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Asset liability management (ALM) is the

administration of policies and procedures


that address financial risks associated with
changing interest rates, foreign exchange
rates and other factors that can affect a
companys liquidity. Asset Liability
Management (ALM) seeks to limit risk to
acceptable levels by monitoring and
anticipating possible prici ng differences
between a companys assets and liabilities.
Initially pioneered by financial institutions during
the 1970s as interest rates became increasingly
volatile, asset and liability management (often
abbreviated ALM) is the practice of
managing risks that arise due to mismatches
between the assets and liabilities.
The process is at the crossroads between risk
management and strategic planning. It is not just
about offering solutions to mitigate or hedge the
risks arising from the interaction of assets and
liabilities but is focused on a long-term

perspective: success in the process of maximising


assets to meet complex liabilities may increase
profitability.
Thus modern ALM includes the allocation and
management of assets, equity, interest rate and
credit risk management including risk overlays,
and the calibration of firmwide tools within these
risk frameworks for optimisation and management
in the local regulatory and capital environment.
Often an ALM approach passively matches assets
against liabilities (fully hedged) and leaves surplus
to be actively managed
ALM relates to management of structure of
balance sheet (liabilities and assets) in such
a way that the net earning from interest is
maximised within the overall riskpreference (present and future) of the
institutions.
Thus the ALM functions includes the tools
adopted
to mitigating liquidly risk,

management of interest rate risk / market


risk and trading risk management. In
short, ALM is the sum of the financial risk
management of any financial institution.
In other words, ALM is all about managing
three central risks:
Interest Rate Risk
Liquidity Risk
Foreign currency risk
For banks with forex operations, it also
includes managing
Currency risk
Through ALM banks try to match the assets
and liabilities in terms of Maturities and
Interest Rates Sensitivities so as to
minimize the interest rate risk and liquidity
risk.

Overview of
mismatches :

what

are

asset

liability

The Assets and Liabilities of the banks


B/Sheet are nothing but future cash inflows
& outflows.
Under Asset Liability
Management i.e. ALM, these inflows &
outflows are grouped into different time
buckets. Then each bucket of assets is
matched with the corresponding bucket of
liability.
The differences in each bucket are known
as mismatches.
Is complete matching of Assets & Liabilities
in the Balance sheet necessary?
No,becausebankscanevenmakemoneyasaresult
of such mismatches sometimes. Alam Greenspan,
exChairman of US Federal Reserve has once
observed risk taking is necessary condition for
wealthcreation.However,itisariskyproposition
tokeeplargemismatchesasitcanleadtomassive
lossesinavolatilemarket.Therefore,inpractice,

theideaistolimitthemismatchesratherthanaim
atzeromismatches.
Evolution of ALM in Indian Banking
System:
In view of the regulated environment in India in
1970stoearly1990s,therewasnointerestraterisk
astheinterestratewereregulatedandprescribedby
RBI. Spreads between deposits and lending rates
wereverywide.AtthattimebanksBalanceSheets
were not being managed by banks themselves as
theywerebeingmanagedthroughprescriptionsof
theregulatoryauthorityandthegovernment.With
thederegulationofinterestrates,banksweregiven
alargeamountoffreedomtomanagetheirBalance
sheets. Thus, it became necessary to introduce
ALM guidelines so that banks can be prevented
from big losses on account of wide ALM
mismatches.
___________________________________________
Difference between life insurance and general
insurance:-

1. There is certainty
as to the happening of
event i.e. death
2. Life insurance is a
type of investment. It
is not a contract of
indemnity
3. In life insurance the
insurable interest must
be present at the time
of contract.
4. Life insurance
contract is for the
whole life of the
insured or for the
assured attaining a
specified agewhichever is earlier.
5. Principle of
subrogation does not
apply to life insurance.

6. Principle of
contribution does not
apply to life insurance.
In case of double

insurance, the insured


can claim full value of
policies from all
insurance companies.
7. There is a
surrender value of
policy, in life insurance
Difference
# General
Insurance (Fire
and Marine):
1. The event insured
against may or may
not happen.
2. The contracts of fire
and marine
insurances are
contracts of indemnity.
The insured can claim
only the actual amount
of loss-subject to a
maximum of sum
assured.
3. In fire insurance,
insurable interest must
be present at both-

time of contract and


time of loss.
4. In marine insurance
insurable interest must
be present, at the time
of loss.

5. A contract of fire
insurance is for one
year. A contract of
marine insurance is
for a particular period
(not more than one
year) or for a
particular voyage or
for both.

6. This principle
applies to fire and
marine insurances.
7. This principle
applies to fire and
marine insurance. In
case of double
insurance, if one
insurance company
pays full amount of
loss to the insured; it
can claim retable
contribution from other
insurance companies.
8. The provision of
surrender value does
not exist, in fire and
marine insurance.