Among the different types of risks, asset and liability management risks are the most common risks in commercial banks. Banks have to bear this type of risk and various quantifiable measures that are usually used to measure risk. We can start discussing this type of governance. Most organizations are dedicated to asset and liability management and banking. This theme focuses on three things: first, the concept of asset and liability management, asset and liability management with risk management, and finally, the technical management of assets and liabilities.
Let’s start with the concept of asset and liability management. This is a dynamic planning and organization process. Control of assets and liabilities and their quantities. From this point on, we can clearly see that asset and liability management is a transition. Asset and liability management can be defined as a resolution mechanism given that they are due to a mismatch between assets and liabilities, or due to changes in liquidity or interest rates, when there are liquidity or interest rate issues, important changes that may lead to a mismatch between assets and liabilities occur. It is directly related to risk management.
These risks may be different types that we need to determine. First, second, we need to analyze, third, we need to develop an action plan to deal with the risk, and fourth, follow-up measures and implementation. Our decision or strategy about this risk, in the end, we need to measure the risk and solve the problems related to asset and liability management, and finally, we can only conclude asset and liability management.
First, it is a gap measurement based on the maturity category. Asset and liability management should measure gaps primarily based on groups. Second, it is necessary to estimate the fund’s revaluation rate and expected future interest income. And interest expenses. Also, please review alternative interest rate plans so that we can balance assets and liabilities. And finally, choose appropriate hedging tools to minimize risk.
Therefore, risks may now arise. We need to develop a hedging tool that can be used as a derivative. In this way, we can minimize this risk by using derivatives or other hedging tools. We will solve some technical issues related to asset and liability management in the future. Direct connection refers to an agreement between two parties through which financial assets can be bought and sold at a specific time and a specific price. This means that the price is fixed on a specific date and the direct contact is personal.
Asset and liability management mainly focuses on managing interest rate risk or certain financial data affected by changes in interest rate fluctuations. How do you fundamentally predict or control these fluctuations? Volatility beyond the grasp of commercial banks. However, due to changes in interest rates, commercial banks only need to pay fees after the book interest rate, and all these data are affected.
Carry out the systematic management of assets and liabilities. As a result, the maximum loss suffered due to interest rate fluctuations is smaller. This is the main purpose of asset and liability management. In today’s course, we will discuss the concept of asset and liability management, its exact meaning, and how to determine the percentage of risk, the different components of interest rate risk, and the measurement of interest rate risk? And it can be controlled; we can discuss interest rate risk management through gap analysis.
If we are to talk about asset and liability management, what is asset and liability management? The bank lends, the banker takes in deposits, and the banker invests; the bank also buys securities from various institutions. Therefore, banks provide many different functions. When banks conduct such transactions with banks, some of them are regarded as instruments or elements of liabilities, and some specific elements are regarded as assets. These assets and liabilities can be changed at any time.
What are the main factors affecting this? Basically, a percentage deduction of interest rate exchange rate will move and this is the first place. Second, what is the composition of assets and liabilities? What is the main structure of the assets and liabilities of this particular bank, and what are the risks? Therefore, these are the different types of factors that mainly determine the bank’s decision-making. Whenever they make such a decision in the market, it is mainly for their benefit we have been saying that the main purpose of commercial banking is to maximize profits and maintain liquidity.
Commercial banking always involves all activities, and banking always tries to manage these activities consistently. Therefore, they mainly manage their assets and liabilities, or the composition of assets and liabilities that they also manage. Decisions about the composition of assets and liabilities and risk assessment are called asset and liability management. Whenever a loan or deposit decision related to investment is made.
Therefore, bankers need to establish positions so that the risk is relatively low. If there is market volatility, they may be less susceptible to such fluctuations. Or they may be more likely to hedge risk, or they may be fully prepared to manage risk in the best way. The Asset and Liability Management Committee (commonly referred to as ALCO) and the Asset and Liability Management Committee make decisions on the composition of the assets and liabilities held by banks to minimize interest rate risk in the market. Or any other risks in the market.
In particular, if you find that we use asset and liability management for other purposes or other types of risks, this is a strategy. But, most importantly, asset and liability management tries to control this interest rate risk. Therefore, the main objective of asset and liability management (ALM) is to manage the interest rate risk of the banking industry. Future changes in interest rates will affect the number of locations and the price of liabilities. If it has an impact on asset prices or yields, the bank will always get assets and all the bank’s expenses related to various liabilities (such as deposits, etc.). The bank suffered.
Therefore, in this special case, we are trying to find out whether these special losses have occurred, or the expected losses that the bank may suffer due to a change in interest rate.
This is mainly measured in terms of interest rate risk. Failure to quote bank assets and liabilities at the same time can have a significant impact on net interest income. Changes in short-term interest rates may affect certain types of assets. However, this will not affect liabilities, and it may also affect liabilities rather than assets. If this harms the bottom line, it is clear that banks are at greater risk in the system.
In this case, this will also affect changes in the value of assets and changes in the value of liabilities. The cost of debt will be affected, but the cost of capital will obviously be affected. If shareholders are affected by equity, it means that the market value of equity is affected. This will then automatically have a greater impact on the overall financial performance of the commercial bank. So when we talk about interest rate risk, this is very special.
Interest rate risk has two components: one is spread risk or reinvestment risk, and the other is price. The risk of changes in interest rates will change the cost of funds for banks and the performance of mutual funds. They can vary according to the quantity. Therefore, changes in interest rates can change the market value of bank assets and liabilities to varying degrees.
Therefore, rising interest rates have a negative impact on prices and a positive impact on the profitability of reinvestment. Everyone should bear the component stocks, reinvestment risk, and price risk at the same time. The same situation can be considered when the interest rate falls. When the interest rate falls, the price will rise, but the investment risk will increase because the return on coupon investment will decrease.
Now, if you see how this special situation happened, how do we deal with it? Therefore, we usually use multiple types of analysis for management. We conducted the agile analysis. We have conducted a profit sensitivity analysis, so this general analysis is basically a static measure of the risks normally associated with the net interest income target, and we have a profit. Sensitivity analysis is a continuation of the gap. Here, we focus on changes in bank profits due to interest rate and balance sheet competition. The two are more or less related, but in the income sensitivity analysis, it is more or less static and relatively dynamic.
So how does it basically work? When we talk about gap analysis, we are basically doing something. Every time a commercial bank conducts a gap analysis, we must go through different steps. What is the status of your liabilities and assets? Now, you classify passive and active people, how do you classify them? What are these assets and liabilities that are sensitive to interest rates but in fact insensitive to interest rates? That is, the value of the ordinary interest rate will change, and its value will not change due to the change of interest rate.
Therefore, it ranks first in this ranking. Then, when we discuss it after classifying it and then naming certain interest-rate-sensitive assets, we call them interest-rate-sensitive assets, Exchange rate-sensitive obligation, we call it RSL, exchange rate-sensitive obligation. As a result, certain assets (depending on interest rates) whose income or interest expenses will not change for a period of time can now be designated as non-interest-sensitive (NRS). They are actually insensitive to fluctuations in market interest rates.
Therefore, we have interest-rate-sensitive assets, interest-rate-sensitive liabilities, and then non-interest-rate assets and liabilities. We are not very worried about the non-interest-bearing part, because it will not and will not be affected by changes in market interest rates. So this is basically our concept. If so, try to think about how to make a specific assessment of these assets and liabilities. This means that we need to consider the maturity classes of these specific assets and liabilities. The sensitivity of interest rates mainly depends on the frequency of price changes.
Therefore, short-term assets and liabilities are more sensitive than long-term assets and liabilities. The most hit assets are short-term assets, not long-term assets and liabilities. Therefore, short-term assets and liabilities are more sensitive to interest rates than long-term assets and liabilities. Assets and liabilities with longer maturities but variable interest rates are also sensitive to interest rates.
When anyone talks about a specific interest rate, there is a specific asset that could have been used for a long time but based on a floating rate loan. The loan is a floating rate loan. Even if the interest rate changes in the short term, it will affect the payment or value of that particular asset. Assets and liabilities, choosing the time period for measurement are very important.
For example, assets and liabilities that are sensitive to interest rates for 60 days may not be sensitive to interest rates after 30 days or other days or 90 days. Rather than the type of expiration we are considering. When we classify interest-rate-sensitive assets and liabilities, as well as interest-rate-sensitive liabilities and non-interest-rate-sensitive assets and liabilities, it is important to consider the maturity date calculation of various repayments.
After this operation is completed, the period of time is called the maturity period payment or planning scope. Repeat the first line so that almost all assets and liabilities are sensitive to interest rates for a long period of time. Time, almost all assets. And liabilities depend on the interest rate you need to consider. Over time, the ratio of interest-rate sensitive and interest-insensitive assets to liabilities will decrease.
There is no such rule, you can usually use the rule to define the time period of time for pricing. In this case, each bank will determine the time required. Therefore, it is a specific bank. The bank decides the period or time limit for the calculation of the specific interest rate or determines the interest rate sensitive assets and interest rate sensitive liabilities of the specific commercial bank that you can actually consider. Sensitive assets Some assets are exchanged rate-sensitive liabilities and some assets are not exchanged rate-sensitive assets and liabilities. For cash, cash is not interest-rate sensitive to any bank, because interest rates will not affect cash. Cash-out at the cash register or cash register.
Therefore, interest rates have little effect on it. Therefore, it is written as insensitive to speed. Then we have short-term inventory. Usually, these are interest-sensitive assets, subject to changes in short-term interest rates. Short-term securities are interest-rate sensitive assets. Floating rate loans are interest-rate sensitive assets. Even if they are long-term. Short-term loans are also interest-rate sensitive assets. Long-term value, there is long-term value, please remember that they are not sensitive to interest rates, because this is a one-year period, because your rate of return or a certain interest rate is fixed within a reasonable period of time.
For example, long-term loans that are sensitive to interest rates but not sensitive to interest rates. In this case, we are dealing with fixed-rate loans and other assets such as real estate, factories, and equipment. Most of these assets are sensitive to interest rates. In a sense, such as line of sight deposition private deposits related to changes in interest rates do not often change their interest rates. Short-term savings have the possibility of interest rate changes, so they are interest rate-sensitive liabilities. It can be changed, the repurchase rate can be changed, so the obligation depends on the interest rate.
Money market deposits change every day, so interest rates are very sensitive. Stocks are not affected by interest rate fluctuations, so they are not sensitive to interest rates. Long-term savings are also sensitive to interest rates. Now, if you take a look, what is an interest-rate sensitive asset, and what is its value? Interest rate-sensitive liabilities? This means that if changes in interest rates affect both liabilities and assets, the net income of that particular bank will develop in the opposite or unfavorable direction. It also had a negative impact.
For example, interest rates will be aggregated to increase net income and interest income, but since the interest-sensitive liabilities of the particular bank are already greater than interest-sensitive assets, the net interest payable will continue to increase. Liabilities tell you whether changes in interest rates will have a significant or potentially positive or negative impact on commercial banks. Therefore, the idea is to correctly identify price-sensitive assets and price-sensitive liabilities.
Therefore, we also need to ensure that banks are shifting to or dominating interest-rate-sensitive assets, or when interest-rate-sensitive debt is dominant. Minimize the specific risk or minimize the fluctuation of the net interest income that the specific bank will bear when the market interest rate changes. Whenever we talk about the impact of interest rate changes on the net interest income of commercial banks. In each maturity period, how to identify interest-rate-sensitive assets and read-sensitive liabilities, and what impact will this have? As we discussed here, the process of making commercial bank decisions about the composition of assets and liabilities and risk management is called the risk assessment of asset and liability management.
Interest rate risk is nothing more than potential losses caused by unexpected changes in interest rates, and such unexpected changes will affect the profitability and market value of stocks. Static risk measurement, usually related to net interest income or target margin. Gap analysis always ranks assets. And liabilities depend on their interest rate sensitivity. Interest rate sensitivity will affect the fluctuation of net interest income or the direction of just changes in net interest income of commercial banks.