Bank Assets and Liabilities

Objectives and functions of

ALCO

Prepared by:
Ali Awais (38750)
Khurram Shahzad (40010)
Shakeel Ahmed (40033)
Nabeel Raza (40031)
Furqan Kayani (39791)

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Role of ALCO in Banking
We have prepared this assignment based on objectives and functions of ALCO in banking sector.

Introduction of ALCO
ALCO, is the abbreviation of assets and liabilities committee. That is a most senior management
committee in any bank of thrift institutions. It basic duties are to coordinate the borrowing and lending
strategy of bank and acquisitions of funds to meet profitability objectives as interest rate changes. It is
much important for any bank, because the business of any bank bases on taking money from depositors
and giving it to debtors or customers. ALCO is also responsible to observe actions by central bank
regarding affects on interest rates.

In any lending institution ALCO is a risk management committee. It generally comprises of most senior
management of institution. Primarily it evaluates, monitor and approve actions relating to risks due to
imbalances in capital structure. For instance, assets and liabilities committee has the duty to set limits on
short term borrowing, whereas lending long-term instruments. Possible factors or risks that could be
considered are operational risk, interest risk, liquidity risk and external actions that may affect the bank’s
strategic balance sheet allocation and forecast. At last ALCO reports to the board of directors generally
and will have responsibilities of regulatory reporting.

There is a confusion that forecast of loans and savings industry is affected by individual associations for
practicing authority of law provided in 1980s. Now the financial institutions are able to evaluate the
difference between interest rates. When the financial services groups were converted into an industry, for
satisfying traditional customers, deregulation of interest rates on deposits and clustering the products by
the competitors are the main causes of to induce saving institutions to re-examine their reach to
assets/liabilities and funds management. Assets/liabilities management must disclose main factors of
increasing or destabilizing of interest gap including, deposits, investments, and purchased monetary
alternatives.

Regulatory environment that is more independent, and the economy is unstable, and concentrated
competitive pressures, and rapid response to rising hi-tech innovations and many of the organizations /
committees responsible for dealing with issues relevant to the property is set. Premature experiences show
that these regulatory responses sometimes do not exist up to prospect, administrative and institutional
spending time unnecessarily consumes large amounts in luck. In short, the uncertainty of the model and
asset / liability management functions in relation to the present time.

However, the record shows the pilot that troubled banks operate with low liquidity, and to provide more
debtors largely of low quality and reliance on low capital, and keep a little command over operating costs
and not correspond to the great compassion of return on assets, producing work of the parties.  Must
manage assets and liabilities/identify and establish the existence of best risk/return trade-off.  Should it be
that the risks cannot be avoided - should be administered with volume restricted to that can be absorbed
into the regular annual profits. 

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Spread. Asset returns and the percentage of the difference between the percentage of the cost obligations -
can be the same way, and to provide interest margin by adjusting the interest rate spread in an attempt to
increase. As an institution, can affect the yield much less in the open market, and increase the overall
profitability of assets in the early focus on investments. Spread loans, however, these solutions may
increase usually re-evaluation of the same generally low trading volume. Some savings banks in the
market successfully serve its customers and the personal attention and prices to be applied through the
provision of outstanding loans, and trade unions were continuing to meet the full spectrum of
customers. Loss of commercial loans to high interest rates and the margin is obtained as a result of partial
or full amount can be lost. The exact effect sought to re-loan interest rates depending on the flexibility.

On the other hand, can buy and deposits at competitive prices through supply management, better
distribution of wealth. Savings to pay the nominal rate, but it may rarely combined expected revenues and
the size of less competitive in the market and clear. However, it is not required by some organizations that
consumers will be very small balance, not to mention interest rates and competitive prices as well as to
maintain the savings may not be sensitive to sounds.

On the third day, and probably a strategy to improve margins / Property changes mix of
responsibility. First, the low liquidity of the savings banks have to reduce cash and short-term investments
in securities and income accounts receivable can be. Has increased some of these actions on liquidity risk
not being able to meet customer needs. Potential negative effects of the establishment of the Association
for the management of monetary assets / liabilities of the Committee is to identify the task.  In addition,
these actions of the lack of news services, which increased operating costs and loss of services that can be
purchased only sediments. Similarly, the savings banks in the short term through the purchase of
securities on the better to reduce liquidity, volatility may increase the funding limit. Since the funds for
short-term, are often less expensive than longer maturities, and the work shows once again the rest of the
income liquidity. Is more aggressive management changes in the yield curve and short-term securities that
were purchased in conjunction with the changes to take benefit of interest rate changes means profit.

As another option, the customer service department to provide less power through increased debt loan, or
construction, and retail and consumer credit and debt in the market lead to aggression.  The potential
consequences of action potential reduction in credit losses and net income is increasing. Also, with high
exposure to credit risk associated with capital funds are estimated - most difficult and expensive access to
sources of institutional funding.

Finally, you can change the economy returns of assets is the percentage of sensitive documents.If it is
expected to raise interest rates, asset management can increase the price of short-and floating rate
liabilities and reduce short-term and variable. If it is expected that interest rates fall, asset management
and reduce the performance sensitivity and increase the performance of sensitive commitments. It may be
due to erroneous assessment of movements in interest rates and clear: a reduction in interest
margins. However, only the combination of the sensitivity of the return on assets and liabilities, and
mortgage companies to miss the opportunity to get additional revenue. We must balance the decisions and
savings portfolio expected return than the risk from each source and use of funds. 

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Asset/Liability Committee Responsibility. Exact responsibilities of the Committee of assets and liabilities
differ between institutions. However, the most ordinary tasks is to oversee the allocation and purchase of
resources to the Commonwealth in order to maximize profits, is still maintained by standards set by the
liquidity, credit quality and capital. Therefore, the Commission must assess the savings and pricing
strategies for loans to finance the purchase and distribution practices, and monitoring of the net interest
margin. The Commission should be assessed and then each of the opening of financial markets
(investment and loan funds and hedge funds), and took control of the customer through the uses and
sources (loans and deposits) funds.

Functions of ALCO
The ALCO is an important feature in the effective management of the assets and liabilities of a bank. The
most fundamental function of ALCO is to oversee the institution’s operations relating to interest rate risk
and liquidity risk and in particular to ensure that the institution has adequate funds to meets its
obligations. Other functions of ALCO will be dependent on the institution’s size and assets/liabilities
mix. It is essential to have a balanced representation in ALCO to represent both the assets and liabilities
sides of the balance sheet. The ALCO is therefore composed of the senior staff of the bank including
usually the chief executive, the chief financial officer, the treasurer, the chief lending officer and the
officer in charge of deposit taking. Other members such as division heads of corporate and retail banking
may also be found in ALCOs of larger banks. ALCO is a subcommittee of Board of Directors. ALCO
comprise of following members or be as decided from time to time by the board. Membership of ALCO
always include CEO, chairman, two non-executive directors and head of treasury.

 Chairman
 CEO
 Non-executive director
 Non-executive director
 Operations director
 GM Finance
 Director of sales and marketing
 Head of Treasury

The chairperson of committee is appointed by Board. For establishing a quorum a minimum of 4 of above
members must be present. In which 2 must be from Board. The members mentioned above should
normally attend meeting. In addition professional advisors and bank officers should be invited depending
on agenda to be discussed. Meeting of ALCO should be call on monthly basis. Chairman of ALCO can
also call any emergency meeting at any time. ALCO has full authority to set Financial Risk Management
Policy, implementation of Financial Risk Management controls, and authorization of proposals and
recommendations brought forward by bank.

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This diagram shows the mechanism of Risk management of a bank and role of ALCO in it.

Objectives
Therefore, the ALCO is a group decision-making, but not the work of the Group.  While members of the
ALCO will be accountable for providing recommendations and guidelines for good, as the Commission
rarely complete application procedures. Despite good intentions, and experience shows that these
compounds have assets and liabilities of the Commission, the results are not parallel to the
expectations. It is useful to learn from the mistakes of the previous regulators.

Managing the Financial Risk. ALCO prepares the policy for managing the possible risk in financial
transactions. Not only drafting the risk management policy, but its duty is monitoring the environment for
successful implementation of this policy.

Review of Interest Rates. ALCO receives the interest rates that are agreed by the institution. ALCO has
the reserved right to change or modify the agreed interest rates. It also monitors the use of interest rate
derivatives used in the management of interest rate risk. ALCO consider, and if it is determined, then
authorize any substantial periodic reformation of the interest rate derivatives portfolio necessary to
improve hedge effectiveness and/or to suitably manage risk profile. It also monitors Financial Risk
Management policy for appropriate interest rate limits and regularly reviews relevant controls of the
policy.

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Interest Rate Risk. ALCO provides the guidelines for market value and earning risk management of main
portfolio relating to agreed interest rates. It also monitor basic risk’s impact on the net interest margins
and authorize any action. ALCO monitor market value and earning risk regarding impact of repayment on
it.

Credit Risk Management. Credit risk is the possibility of losses related with decrease in credit quality of
credit borrowers and counterparties (KHAN 2007 p114). ALCO has the authority to consider, determine,
and approve the list of investment counterparties and review it after a specific time period. ALCO
consider, determine and authorize any changes in Financial Risk Management Policy regarding credit and
counterparty risk.

Funding. ALCO provides guidelines regarding funding and authorize any changing in Financial Risk
Management Policy regarding Funding.

Foreign Exchange Rate Risk. ACLO give limits for levels of foreign exchange risk. Review and monitor
the activities of bank. ALCO has also the right to consider, determine, and authorize any changes in
Financial Risk Management Policy regarding foreign exchange rate risk.

Performance in Interest Margin and Profit. ALCO review the performance of profit, and any changes In
planned net interest rate margin. It monitor the impact change in market value of derivatives, liquid
assets, and embedded derivatives on net interest margin, profit and reserves.

Liquidity Risk. ALCO has authority to consider, determine and authorize any recommendation of bank
regarding liquidity risk. T also handles the changes in Financial Risk Management Policy regarding
liquidity risk. It periodically review liquidity requirements on a bi-annually basis.

Capital Structure. ALCO consider, determine and authorize recommended by bank regarding capital
investment strategy including optimum duration for capital provided and the interest rate that is agreed
and authorize any necessary actions.

Other Matter. In other objectives ALCO provides guidance on product mix. Determine about recruitment,
training and development of board, ALCO, audit and treasury personnel. Receive the audit report and
authorize necessary actions.

Conclusion
Consequently, we can say that to maintain the structure of assets and liabilities of a bank the role of
ALCO is vital. ALCO provides the bank an internal shield to protect from any deregulations regarding
margin in interest rates and other fatal risks. ALCO ensure a sustainable profitability for bank. It function
as a senior level committee that controls Financial Risk Management Policy. The core risks that are
handled by ALCO include Financial Risk, Foreign Exchange Risk, Interest Rate Risk, Credit Risk, and
Operational Risks. ALCO not only consider and provide direction and guidelines regarding these risks but
authorize any necessary acations to overcome these risks

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Bibliography:

Website

William C. Handorf, Michael P. McCarthy. (1984). Asset and liability management: form and
function of the committee. Available:
http://findarticles.com/p/articles/mi_m6201/is_n3_17/ai_3209770/pg_2/?tag=content;col1. Last
accessed 1st Nov, 2010.

Investopedia. (2010). Asset/Liability Management. Available:

http://www.investopedia.com/terms/a/asset-liabilitymanagement.asp. Last accessed 1st Nov,
2010.

Karla Brom. (2009). Better Asset and Liability Management: an urgent need. Available:

http://www.cgap.org/p/site/c/template.rc/1.26.10804/. Last accessed 

Books
Alexandre Adam (2007). Handbook of Asset and Liability Management. Chichester: Wiley
Finance. 263-277.

Peter Moles, Nicholas Terry (1997 ). The handbook of international financial terms. 9th ed.
Chichester: Oxford University Press. 366.

Moorad chuoudhry (1997 ). Bank asset and liability management. london: wiely finance. 327.

Johan W.Bitner (1992). successful bank asset/liability management. 9th ed. canada: published
simultaneously in canada. 58.