Asset liability management is a method of handling of risks, which result because of inequality between the liabilities and assets (assets and debts) of a bank.
Asset Liability Management functions as a strategic management device for handling different types of risks confronted by the banks.
About Asset Liability Management
The concept of Asset Liability Management is very much appropriate in case of banking. Banks are exposed to different types of risks, for example, interest rate risk, liquidity risk, operational risk and credit risk. These risks may arise as a result of inequality between the liabilities and assets of a bank.
Asset Liability Management or ALM plays the role of a strategic management device to handle liquidity risk and interest rate risk experienced by the banks. Besides banking institutions, asset liability management techniques are also applied by other financial services providers and commercial entities.
Banks handle the risks associated with the inequality in assets and liabilities by the means of balancing the liabilities and assets in accordance with the maturity period or equating the maturity period with the help of securitization and hedging. The majority of hedging methods originate from the ideas of delta hedging presented in the Black-Scholes Model and in the research done by Robert A. Jarrow and Robert C. Merton. In the United States, the source of Asset Liability Management goes back to the periods of 1975-76, the latter part of 1970s, and the earlier part of 1980s when high rates of interest were charged. This history has been drafted by Van Deventer, Mesler, and Imai in an elaborate manner.
The contemporary concepts of risk management are based on a structured approach towards enterprise risk management, which demonstrates that credit risk, interest rate risk, liquidity risk, and market risks are all interconnected. The Jarrow-Turnbull Model is a pattern of risk management techniques, which consolidates default and stochastic rates of interest.