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Asset Liabilty Management

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Published: 24th December 2010 by William Webster

In the proposed "Dear CEO letter" on Senior Asset & Liability Management Committee Practices (November 2010) the FSA picks up on ALM. Why is the FSA addressing this topic?

ALM is about managing balance sheet risks. This used to be about interest rate exposures and structural risks. But now things are a lot more complex.


In performing its role the ALM committee undertakes a crucial role in managing the balance sheet within the limit restrictions dictated by the Board's risk appetite. It's time to ensure this process is robust. With this in mind the FSA is suggesting you review four things:


1. The role of the ALM committee. It's time to dust off the committee's delegated power and ask just what does it do? If you read the FSA's opinion you may well find that you need to expand on the scope and the purpose of the committee. In particular consider interest rate risk, FX risk and liquidity risk. Make sure you capture NII and market value and apply the appropriate stress tests and contingencies.

2. The composition and authority of the committee. The FSA notes that the most effective ALM committees are formal sub committees of EXCO and are chaired by the CEO. They are attended by business heads, the CFO, Treasurer, the Chief Risk Officer, the Head of Internal Audit, the Head of Market Risk, the Head of ALM and the Chief Economist. In smaller firms NEDs may attend on a regular basis. Ask yourself is someone missing?

3. The forward looking nature of decisions made by the committee. In light of the regulatory focus on forward looking risk it is not unsurprising that the FSA is critical of the lack of information and decision making that relates to the future management of risk. This is a prod to encourage additional reporting that not only shows what has happened but based on the planning process what may happen. If you are in doubt think about the projection of your liquidity buffer and ask what other risks are reported in a similar forward looking manner?

4. The degree of challenge observed at the committee. Lack of challenge questions whether the committee is truly effective and this worries the FSA. This observation is not surprising given the complex level of management information that is being reported in the information pack. Ask yourself this. Do all members really understand what each risk report is telling them? After all who is going to challenge if they don’t feel on firm ground?

Is anything missing in the CEO letter? Yes I think there are a two of items that that the FSA has side stepped.

The first is that to be an ongoing solvent business you need to make profit. ALM committees are about balancing risks and rewards. It is therefore surprising that the FSA fails to acknowledge the importance of profitability in shaping decisions. Profitability is a key part of risk taking and this surely needs recording in committee minutes?

The second is the quality of management information contained in information packs. Experience tells me that not only can risk go unreported sometimes the reported risk is factually incorrect. Debate is healthy. It helps uncover duff information.

Finally some of the real gems of the FSA's letter are buried in Appendix 2. The one I really like is:

"A meeting before the ALCO meeting had reached a different view to the one at ALCO, and one or other view is overruled."

This is real life. It shouldn’t happen but it does and when it does it seriously undermines the regulator's best intentions.

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