In this assignment we would be discussing the various important aspects of Asset & Liability Committee (ALCO) which one of the important body of Banking system and which also regulates the banking system as a whole. Introduction of Asset & Liability Management (ALM), one of the key body of banking industry because of higher financial volatility, introduction of new products of new financial products such as interest rate swaps, options and futures , regulatory initiatives. In this paper we would learn about the relation of ALOC to the banking Industry, its functions of ALCO which its performance and also the objectives of ALCO in banking industry.
We, would also be focusing on various key element of banking industry like the financial risk management, also review of interest, rate of risk on the interest which banks carry, credit risk for the banks, various funding methods which bank adopts, ALM reports regarding the banking functions, the capital structure of whole banking system, rate of exchange like (i.e. foreign currency risk and interest rate risk like future & options) and other matters which are related to the ALCO as a governing body of banking industry.
Introduction to ALCO:
Asset & Liability Committee (ALCO) is formed of board of members, where the board of members are the key authority and they are appointed from time to time and other members are also appointed my the board of members.
Membership of ALCO:
ALCO consist of the following members which forms the part of the committee and form a part of the list is mentioned below:
Chairman (Deputy Chief Executive)
Chief Executive,
Non Executive Directors
Operations Director
General Manager Finance
Direct f Sales and Marketing
Head of Group Treasury (Secretary)
The Chairman of ALCO is appointed by the board.
Formation of ALCO:
To form a committee the minimum criteria that there should be a least four of the members from the above list should be present, two the board members of the board of which at least one should be a non-executive director of the society.
Response from ALCO:
To, any decision regarding the any response from the organization regarding the meeting there needs to be at least three members of the above it needs to be present and out of which the two members should be from the board. Any decision relating to the finance and also regarding the asset and liability of the bank needs to be discussed at this ALCO meeting.
Meeting of the Members:
The above members mentioned should be present in the meeting and other professional persons and also some of the senior people of the organization should be present the meeting to there could be a rapid response to the agenda of the meeting.
Duties of the ALCO:
The items cited below do not necessarily represent an all-inclusive list of the duties of the ALCO, given the dynamic nature of its responsibilities. On a regular basis the ALCO should:
Hold a formal meeting (usually once a month). Informal meetings will be held on an as needed basis.
Monitor and discuss the status and results of implemented asset/liability management strategies and tactics.
Review the current and prospective liquidity positions and monitor alternative funding sources.
Review measurement reports on various risks that can be measured with a reasonable degree of effort. Compare simulated exposures of these risks to policy limits. Discuss and report on the impact of major funding shifts and changes in overall investment and lending strategies.
Review the current and prospective capital levels (risk-based as well as net worth) to determine sufficiency in relation to: expected growth, interest rate risk, price risk, and asset mix/quality.
Review outlook for interest rates and economy at local, regional and international levels.
Review maturity/repricing schedules with particular attention to the maturity distribution of large amounts of assets and liabilities maturing (i.e. jumbo CD's, large investments, etc.)
Develop alternate strategies deemed appropriate, which take into account changes in:
interest rate levels and trends,
deposit and loan products and related markets,
banking regulations, and
Monetary and fiscal policy.
Develop parameters for the pricing and maturity distributions of deposits, loans and investments.
Report the minutes of each monthly meeting to the Board of Directors.
Perform an independent review (using our internal audit staff) of the validation and reasonableness of the input, assumptions, and output of our Asset/Liability Management Model (if installed), or procedures.
Coordinate an on-going appropriate education program on the subject of ALM for the ALCO members, senior management, and the Board of Directors.
Also, the ALCO will ensure that it is aware of the overall financial performance of the Bank and, therefore, will keep abreast of significant changes/trends in its financial results. In this regard it will:
Review actual net interest income and asset/liability distribution versus budget.
Measure performance against established standards and, if appropriate against peer group data.
Review the level and makeup of non-earning assets.
Review the liquidity and contingency funding conditions of the Bank.
Given the importance of the ALCO in the management of the Bank's balance sheet and related earnings stream, the ALCO will review the annual budget.
Primary Objectives:
All financial institutions assume some amount of risk as part of normal operations. The primary objectives of the Bank's asset/liability management process include:
Interest Rate Risk (IRR) - risk that changes in prevailing interest rates will adversely affect the earnings stream of the Bank, thus resulting in reduced net interest income.
Price Risk - Risk that changes in prevailing interest rates will adversely affect the values of assets, liabilities, and capital. Price Risk is the Balance Sheet valuation effect due to changes in Interest Rates and other market factors both internal and external to the Bank.
Liquidity Risk - risk that not enough cash will be generated from either assets or liabilities or outside sources to respond to the needs of Customers.
Credit Risk - risk that some loans and investments may not be repaid (default risk); implications of asset mix on risk-based capital and asset quality on ability to leverage the Bank's capital.
Other Risks:
Other risks may be measured from time to time. However, their importance is also key to the Bank's continued successful operations. The ALCO will review these risks at least annually, and more often as conditions may warrant.
Operations Risk - risk that errors made in the course of conducting business will result in losses.
Compliance Risk - the risk from violations or non-conformance with laws, rules, policies (regulatory or internal), and ethical standards.
Yield Curve or Mismatch Risk - risk of adverse consequences from a change in interest rates that arises due to differences in the timing of interest rate changes on the Bank's assets and liabilities.
Basis Risk - risk that the spread between instruments of similar maturities will change.
Liquidity Risk:
Liquidity risk is the risk of having to fund some assets by the acquisition of additional funds under unfavourable market terms. This might occur when unexpected clearing drains occur in close proximity, when depositors are leaving the bank due to a perception of increased risk, or when loan growth is very strong.
Funding:
Forecasting future events is essential to adequate liquidity planning. Sound financial management can help buffer negative changes in the Bank's economic climate and accentuate positive ones. Forecasting of future events is very subjective and fraught with potential error. Management must therefore develop contingency plans in case its projections are wrong. Effective contingency planning involves identifying minimum and maximum liability needs and weighing the alternative courses of action designed to meet the needs. Monthly cash flow projections will be sought from large customers.
The following are alternative ways the Bank can meet its liquidity needs:
Increase core (retail) deposits
Acquire interbank deposits
Sell large time or notice deposits in domestic money market
Borrow from Lender of last resort (Central Bank)
Borrow on the Inter-Bank Market
Lengthen the average life of the bank's liabilities portfolio
Maintain unused lines of credit with other financial institutions
Loan participations
The ALCO will review annually, as part of the annual budget preparation, or as often as necessary, the Bank's deposit structure in relation to volume and trend of various types of deposits, maturity distribution of time deposits and rates paid compared to rates offered by competitors.
Investments:
Investments purchased will be consistent with a separate written investment policy. The objectives of the investment policy are to (1) provide liquidity (2) provide for interest rate risk management, and (3) provide additional profit. The investments portfolio shall be diversified to minimize the risk of loss resulting from over concentration of assets in specific class, currency, Country, or economic sector.
The Bank shall adopt a flexible weightings approach (strategic asset allocation) involving the periodic adjustments of the weights for each category based either on the market analysis or on technical analysis (i.e., market timing). A new allocation therefore may be constructed to capture greater returns in a changing market.
Interest Rate Risk Management:
Interest rate risk arises when there is a mismatch between positions which are subject to interest rate adjustments within a specified period. The most important source of interest rate risk is the Bank's lending, funding and investment activities, where fluctuations in interest rates are reflected in interest margins and earnings. Interest rate risk also arises in trading activities, where changes in interest rates may cause fluctuations in portfolio market values.
The Bank will strive to achieve a balance between reducing risk to earnings from adverse movements in interest rates, and enhancing net interest income through correct anticipation of the direction and extent on interest rate changes.
Credit Risk Management:
Credit risk is the risk of loss resulting from the failure of a borrower or counterparty to honour its financial or contractual obligation. Credit risk arises either in the Bank's direct lending operations or in its funding, investment and trading activities, where counterparties have repayment or other obligations to the Bank. The management of the Bank's credit risk shall be consistent with separate written credit policies and procedures.
Foreign Exchange Rate Risk:
a. The primary objective of ALCO is to manage the limits of the currency which are related to foreign exchange.
b. To authorise any changes related to foreign exchange risk and take actions related to any foreign exchange rate risk and approve them considering the requirement.
c. It also had the right to change any policies related to foreign exchange rate risk and regularly review whether the policies are in place and are implemented on the regular basis.
Capital Structure:
The basic objective of ALCO is to approve and recommend changes related to capital structure, capital investments, plan strategy regarding the capital investments and also agree upon the interest rate. It, also takes actions arising out of any issues related to financial management.
It, also reviews any changes due to any policies changes or capital structure changes and has to assure that the policies are in place and well implemented.
(Source: http://www.documentsplace.com/sample_asset_liability_management_policy.htm)
Features of ALCO:
The ALCO is responsible for setting, implementing the ALM policy. It, varies from bank to bank, but it includes the business heads, as well as directors of finance.
The processes of the ALCO are carried out by Treasury desk and any other function carried in the bank.
ALCO discusses the matters and views the reports on regular basis, usually the meeting are carried on the weekly basis.
Various points have to be discussed in the meeting like the interest rate fluctuations in income, areas which had the maximum fluctuations and also what are the short term targets for the banks.
ALCO links all the activities of the bank into one entity and considers it a one business.
It, also considers various macro-economic factors which would affect the interest rate income and all the reports are largely documented.
It also has various features which are related to ALM and are carried out on regular basis:
Managing reports.
Business Planning
Hedging policy
(Source: Moorad Choudhary. (2007). Asset and Liability III. In: Bank Asset and Liability . Singapore: John Wiley & Sons Asia (Pte) Ltd. 327-329.)
Conclusion:
From the above essay we can conclude that the ALCO plays an very important role in banking industry and regulates all the activites related to finance or decision making. As, ALCO is an important entity in ALM, the key objectives and features discussed in the essay relate to banking needs to be regularly viewed. ALCO as the part of banking and finance looks at all the needs of banking industry
