No business is risk-free. Almost every business has some risks. In the same way, a bank is faced with some risks. There’s a mechanism to face these risks called asset and liabilities management (ALM). The risks involved in it are not common ones. These are the risks that arise due to contradictions between assets and liabilities. If these are not addressed on time, they can make your business bankrupt.
Changes in interest rates
Changes in interest rates are the common factors. These changes in banking terms are known as liquidity. In other words when you take out of the box measures to cope with the risk faced by your bank; you are dealing with asset and liabilities management.
You may have known the term ALM which stands for Asset Liability Management. In fact, ALM is a mechanism to deal with the risk your bank is facing with on account of a variance between liabilities & assets either on account of liquidity or variations in the rate of interest.
What is liquidity?
When talking about liquidity separately, it is a specific capability of an institution to fulfill the responsibilities anyhow. Liquidity is the name of meeting the liabilities either by taking a loan or by converting assets.
A mismatch can occur on account of changes to the interest rates
A mismatch can occur on account of changes in the interest rates over and above liquidity. A bank has to borrow for a short term as well as lending for a long term. A detailed ALM strategy mechanism concentrates on the profitability as well as viability for a long term by focusing the NIM (Net Interest Margin) ratio and NEV Net Economic Value with regards balance sheet constraints. Prominent among the limitations are dealing with the quality of credit, achieving liquidity, and gaining enough revenue.