Foundations
What is Asset-Liability Management?
Asset-Liability Management, or ALM, is the discipline through which banks manage the structure,
risks, and profitability of their balance sheet. Every bank has an ALM function because banking
is fundamentally a leveraged balance sheet business: unlike most companies, which operate with
a relatively balanced mix of equity and liabilities, banks deliberately keep capital low and the
funding side of the balance sheet relies heavily on deposits, wholesale funding, and other
liabilities, which are used to generate income from loans, securities, and other assets.
The importance of ALM became especially visible after the failures and stress events involving
Silicon Valley Bank, Credit Suisse, and other European banking
stress events in 2023, where weaknesses in liquidity, interest rate risk management, and balance
sheet positioning translated rapidly into banking crises.
A weak ALM strategy will create significant costs for banks: drag in returns, inefficient use of
the balance sheet, poor pricing decisions, suboptimal capital allocation, and a balance sheet that
may comply with banking regulation but fails to maximize profitability.
Liquidity
Liquidity — Regulatory Framework
Under Basel III, banks are required to maintain minimum liquidity standards designed to ensure
they can survive periods of market disruption and deposit or funding stress. These requirements
were introduced as part of the post-2008 Global Financial Crisis reform agenda, when regulators
recognized that capital strength alone was not enough if a bank could not meet its short-term
obligations.
Basel III introduced two core liquidity ratios: the Liquidity Coverage Ratio (LCR)
and the Net Stable Funding Ratio (NSFR). The LCR is a short-term liquidity metric
designed to ensure that banks hold enough high-quality liquid assets to survive a 30-day stress
scenario, while the NSFR is a longer-term structural funding metric designed to ensure that banks
fund their assets and activities with a sufficiently stable funding profile over a one-year horizon.
Liquidity Coverage Ratio — LCR
The Liquidity Coverage Ratio measures whether a bank has enough
High-Quality Liquid Assets (HQLA) to cover its expected net cash outflows over
a 30-day stress period. HQLA generally includes assets that can be converted into cash quickly
and reliably, even during periods of market stress — such as cash, central bank reserves, and
certain high-quality government or marketable securities.
The purpose of the LCR is to promote short-term resilience by ensuring that a bank can withstand
a severe but plausible liquidity shock without immediately relying on external funding markets.
Net Stable Funding Ratio — NSFR
The Net Stable Funding Ratio measures whether a bank's assets and off-balance-sheet exposures
are funded with a sufficiently stable mix of capital and liabilities. Unlike the LCR, which
focuses on short-term liquidity survival, the NSFR focuses on the structural stability
of the balance sheet over a longer horizon — typically one year.
The ratio compares a bank's Available Stable Funding (ASF) — which comes from
capital and liabilities considered reliable — against its Required Stable Funding
(RSF) — which depends on the liquidity characteristics and maturity profile of the
bank's assets and off-balance-sheet exposures.
Internal Liquidity Management
On top of regulatory requirements such as the LCR and NSFR, banks also maintain
internal liquidity stress testing frameworks. These internal models assess
whether the bank has enough liquidity resources under stress conditions that may be more
specific, severe, or institutionally relevant than standardised regulatory metrics.
Typically, banks begin with today's balance sheet and apply internally defined stress assumptions
to estimate how deposits, wholesale funding, loan commitments, secured funding, derivatives, and
other balance sheet items may behave during a financial crisis. These assumptions often include
both idiosyncratic stress (a bank-specific confidence event) and
market-wide stress (a broader liquidity crisis).
Through historical analysis, statistical models, regressions, behavioural assumptions, and expert
judgment, banks estimate appropriate runoff rates and inflow assumptions for different categories
of assets and liabilities. The objective is to understand what the balance sheet would look like
if a severe liquidity event occurred today.
To be considered resilient, banks typically need to remain above predefined internal liquidity
limits, triggers, or survival horizons established by management and approved through the
bank's risk appetite framework.
This process allows banks to determine whether they have a liquidity surplus or deficit under
stress — performed across both short-term horizons (typically 30 days) and longer-term horizons,
depending on the institution's liquidity risk appetite and internal governance framework.
