In banking, asset and liability management (often abbreviated ALM) is the practice of managing risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank. This can also be seen in insurance.
Banks face several risks such as the liquidity risk, interest rate risk, credit risk and operational risk. Asset liability management (ALM) is a strategic management tool to manage interest rate risk and liquidity risk faced by banks, other financial services companies and corporations.
Banks manage the risks of asset liability mismatch by matching the assets and liabilities according to the maturity pattern or the matching of the duration, by hedging and by securitization. Much of the techniques for hedging stem from the delta hedging concepts introduced in the Black–Scholes model and in the work of Robert C. Merton and Robert A. Jarrow. The early origins of asset and liability management date to the high interest rate periods of 1975-6 and the late 1970s and early 1980s in the United States. Van Deventer, Imai and Mesler (2004), chapter 2, outline this history in detail.
Modern risk management now takes place from an integrated approach to enterprise risk management that reflects the fact that interest rate risk, credit risk, market risk, and liquidity risk are all interrelated. The Jarrow-Turnbull model is an example of a risk management methodology that integrates default and random interest rates. The earliest work in this regard was done by Robert C. Merton. Increasing integrated risk management is done on a full mark to market basis rather than the accounting basis that was at the heart of the first interest rate sensivity gap and duration calculations.
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