In the news
Behind the headlines of banking’s asset-liability mismatch, the underlying issue for bank leaders is how to gain a more holistic view of their balance sheet risks.
Silicon Valley Bank, of course, is a textbook example of wildly imbalanced assets and liabilities. On the assets side, SVB had invested short-term deposits in long-term Treasury securities that accounted for more than 50% of its portfolio. The bulk of the securities had a maturity of more than five years. On the liabilities side, 97% of SVB accounts held more than the $250,000 limit insured by the FDIC.
While the failures of SVB and Signature Bank involved risks hiding in plain sight, as JPMorgan Chase CEO Jamie Dimon wrote in his annual letter to shareholders, it's the job of asset and liability management (ALM) to red-flag potential mismatches.
ALM is critical to banks’ profitability and stability: It enables them to not only strategically manage and monitor assets and liabilities but also ensure they can meet their obligations over time and maintain solvency.
Banks can rebalance ALM in a variety of ways. Some should sell investment portfolios at a loss and increase deposit rates to stem withdrawals. Others could raise additional capital to improve liquidity. In some cases, banks borrow money to shore up their balance sheet, as First Republic Bank did when it received deposits worth $30 billion from a group of major banks including JPMorgan Chase and Citibank.
As is also the case with liquidity management and the onboarding of commercial depositors, the financial sector’s instability highlights the need for banks to increase their accountability in ALM.
The Cognizant take
ALM’s broad implications require banks to expand their scope beyond interest rate risks and conduct a holistic review of all balance sheet risks. These risks can no longer be evaluated in isolation from liquidity and credit risks, funds transfer pricing or capital management.
“The most successful long-term solution is to apply more rigor to the ALM process,” says Sanghosh Bhalla, Senior Banking Consulting Principal in Cognizant’s Banking and Financial Services division. “By proactively managing their assets and liabilities with a meticulous assessment of key risk types—interest rate risk, as well as liquidity, credit and operational risk—banks are better prepared to gauge how changes in market conditions or business operations can impact their balance sheet.”
Key actions include comparing their ALM scenario with those of competitors, and determining whether they have a comprehensive view of all assets and liabilities, says Bhalla. He adds that all banks need to undertake a thorough review of the major types of assets held, and the maturity profile of the assets and liabilities.
Sophisticated ALM technology capabilities—fed by timely and consistent data—can help banks gain the holistic view they need. “The ability to generate integrated risk models, insights and reports is key to a modern ALM strategy,” says Pradeep Mandalik, Senior Banking Consulting Director in Cognizant’s Banking and Financial Services division. Banks need advanced data and analytics capabilities to derive implications across multiple risk types in an integrated fashion.
By analyzing insights and reports across different scenarios and risk models, banks are better positioned to implement risk management strategies while adjusting the mix of assets and liabilities, hedging against risk exposures, or changing business practices, Mandalik says.
Finally, he adds, banks should continually monitor their portfolio and risk profile and adjust their ALM strategies to ensure they remain aligned with its goals and risk appetite.