Q. Asset-Liability Management (ALM) in the banking sector is a critical process. In this context, consider the following statements:
1.The primary focus of ALM is the management of credit risk, especially the Non-Performing Assets (NPAs), which are the main assets of a bank.
2.The Duration Gap Analysis is a technique used in ALM to measure the bank’s exposure to changes in interest rates.
3.By actively managing the maturity profile of its assets and liabilities, ALM helps a bank to effectively hedge against both Liquidity Risk and Interest Rate Risk.
Which of the statements given above is/are correct?
Explanation:
Statement 1: Incorrect. While Credit Risk (leading to NPAs) is crucial, the primary focus of Asset-Liability Management (ALM) is the management of risks arising from mismatches in the size and maturity of a bank’s assets (loans, investments) and liabilities (deposits). The main risks addressed by ALM are Interest Rate Risk and Liquidity Risk. Credit Risk is managed through a separate credit assessment process.
Statement 2: Correct. Duration Gap Analysis is a key tool in ALM. Duration measures the sensitivity of an asset or liability’s price to a change in the interest rate. The duration gap measures the overall interest rate risk exposure of the bank’s balance sheet.
Statement 3: Correct. ALM ensures a bank has sufficient funds to meet deposit withdrawals (Liquidity Risk) and minimizes the negative impact on net interest income/net worth from adverse movements in market interest rates (Interest Rate Risk).
