What is asset-liability management? How does it contribute to your business? Here’s a bit of explanation why asset-liability management is needed in your business.
In financial statements, assets and liabilities can describe the financial position of an organization or company.
For this reason, the organization or company must be able to optimally manage its assets and liabilities through the determination of a reliable strategy to achieve business performance based on its scale and complexity.
What is asset-liability management?
Asset-liability management is an activity that aims to control the use of assets and cash flows in order to limit the risk of a company losing money due to late payment of a liability.
Assets and liabilities that are well-managed can boost the profits of a corporation.
Bank loan portfolios and pension plans are common examples of asset-liability management.
Asset and liability management includes a variety of things, such as strategic asset allocation, risk reduction, and regulatory and capital framework adjustments.
When assets and liabilities are correctly matched, financial institutions are left with a surplus that can be actively managed to maximize investment returns and profitability.
Types of asset-liability management risk mitigation
Here are some types of asset-liability management risk mitigation:
1. Interest Rate Risk
Interest rate risk is the risk of future cash flows being affected by changes in interest rates. Changing interest rates have an impact on financial firms’ assets and liabilities.
Deposits (assets) and loans (liabilities) are two common instances. Interest rates affect both, therefore a changing rate environment might cause a mismatch between assets and obligations.
2. Liquidity Risk
Risks related with a financial institution’s capacity to meet its current and future cash-flow obligations, commonly known as liquidity, are referred to as liquidity risk.
When a financial institution is unable to satisfy its obligations owing to a liquidity constraint, it runs the danger of damaging its financial situation.
To mitigate the liquidity risk, organizations may implement procedures to increase liquidity to fulfill cash-flow obligations resulting from their liabilities.
Aside from interest and liquidity concerns, asset-liability management also mitigates against a variety of other risks.
Currency risk, for example, refers to the risk of fluctuating currency rates. Changes in exchange rates can cause a mismatch between assets and liabilities when they are held in different currencies.
Another example is capital market risk, which refers to the dangers that come with fluctuating stock prices. Futures, options, and derivatives are commonly used to reduce such risks.
Examples of asset-liability management
1. In Banking Industries
Banks serve as a financial link between their consumers and their future. Banks collect deposits from their customers and are obligated to pay interest on such deposits.
They provide loans for which they obtain interest income from these deposits.
To achieve a balance between net interest income and the ability to pay off customer deposits at any moment, banks must employ good asset-liability management.
2. In Insurance Industries
There are two forms of insurance offered by insurance companies: life and non-life. Property and car insurance are examples of non-life insurance.
Insurance firms are paid by other parties, yet they are compelled to provide a lump sum amount when it is needed. As a result, they must ensure that they have sufficient funds to pay off their debts at all times.
3. Future Retirement Plans
Future retirement plans, for example, take a portion of an employee’s salary and pay it out in the future at the applicable rate at the time of retirement.
These organizations must ensure that they have sufficient cash to meet their obligations.
Asset liability management is a crucial concept that is applied in a variety of businesses. By raising net interest revenue, an effective asset management policy framework can help banks increase their profitability.
A better view might be thought of as a well-coordinated process of putting the right balance sheet components together. The gist of the strategy is that businesses should have enough assets to pay down their debts.
Asset liability management is a systematic technique to protecting against the risks associated with asset-liability mismatches.
Therefore, the company needs to understand a good asset-liability management to be able to mitigate the risk.
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