Figuring Asset Liability in the Global Market

Article excerpt

Figuring Asset Liability in the Global Market

During the past decade, banking has become increasingly multinational. Barriers between United States financial institutions and foreign entities were lowered or fell altogether during the Reagan years.

And banks leapt at the opportunity, opening overseas divisions to service their increasingly international commercial clientele.

Additionally, major U.S. banks, which formerly invested almost exclusively in U.S. securities, increased their investments in Europe and the Far East in search of stronger returns.

The consolidation in the banking industry in the United States has seen a great number of community banks merged into major financial institutions. And many of these big institutions have overseas operations, investments, and exposure.

How do you factor this new exposure into your asset-liability management efforts in an industry largely dependent on margins for income?

A simulation model is an important part of the asset-liability management process. However, buying a model does not solve problems of asset-liability management, interest rate risk, or currency risk; asset-liability management is too complex for a simple solution.

This is most clearly true when one looks at the interplay between interest rates and currency fluctuations. Asset-liability management is a process that can change drastically from month to month.

Don't let the input and output from your model become the definition. Managements need to understand how a particular asset-liability model relates to their institutions.

Many Factors Involved

This is difficult because the process has many components.

Asset-liability management involves concepts like simulation, transaction analysis, capital planning, regulatory compliance, multicurrency transactions, loans, borrowing, investments, rate and currency swaps, general ledger, product profitability, and market value.

Frequently all of the components come from incompatible subsystems managed by different units in an institution.

To be properly understood, these different aspects need to be divided into manageable parts.

This is considerably different from the "let's put it all in the model and see what it tells us" approach.

To understand this scattered and flawed approach, which is used by many institutions, one needs to examine the evolution of the asset-liability management process.

From Simple to Sophisticated

Asset-liability management process emerged over a considerable period of time, with different disciplines sprouting within various organizational areas.

Initially, it began with budgeting questions like: "What is most likely to happen in the next year?"

Then a planning aspect appeared. In addition to the most likely scenario, one or two other cases were considered. Institutions began to view and to protect themselves from alternative interest rate and growth scenarios.

Later, institutional planners began to shift from a macro approach to the micro. Rather than looking at the entire balance sheet, they looked at subsets or individual portfolios, asking the same questions about alternative growth and interest rate scenarios.

In the field of simulation models, we began to see more interest in larger and more charts of accounts and scenario comparisons.

Interplay of Risks and Rates

Finally, the more sophisticated institutions began to analyze risks. …