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This article examines current practice, the mandate, and challenges facing ALM that emerged from a McKinsey & Company survey. Conducted in 2006 and 2007, the survey included 29 participants from 17 countries.
THE TRADITIONAL BUSINESS model of commercial banking was to finance long-term loans with relatively short term liabilities. In the heavily regulated environment that prevailed up to the 1970s, this business was relatively simple; banks had only to worry about the creditworthiness of their borrowers and focus on earning a positive spread. Stable interest rates allowed asset decisions to be made independently from decisions about liabilities. The maturity gap between the two sides of a bank's balance sheet was not much of an issue.
All this changed in the late 1970s for two important reasons. First, the focus of monetary policy switched from stabilizing interest rates to controlling monetary aggregates. Second, the 1980s ushered in a new age of deregulation that started with the elimination of interest rate restrictions. These changes resulted in an increase in the volatility of interest rates and a shift in the value of both bank assets and liabilities. When interest rates rose sharply from 1980 to 1982, many banks and thrifts became insolvent and ultimately had to be liquidated. The value of the assets of institutions that regulators closed during this period is estimated to be over $500 billion.
The lesson from this historical episode was that a more integrated treatment of a bank's balance sheet risk is essential for consistent financial performance. The individual characteristics of a single asset or liability-its interest rate terms, the currency in which it is denominated, and its liquidity-are important, but so too is the relationship between the two sides of the balance sheet. Managing these inter-relationships is usually referred to as asset and liability management, or ALM, which reached maturity in response to the turmoil of the 1980s.
Then came the 1990s. Interest in ALM receded as the banking industry focused on its list of new priorities-pressing issues such as the removal of barriers to competition, the growing choice of alternative assets, and the trend toward industry consolidation. The new millennium saw expansionary monetary policy, which produced historically low and stable short-term interest rates and a nicely upward sloping yield...