Cover
Title Page
Preface
PART 1: ASSET AND LIABILITY MANAGEMENT
1. CHAPTER 1: Managing Bank Profitability
  1. Introduction
  2. Structure and Regulation
  3. Financial Statements
  4. Evaluating Banks' Profits
  5. Measuring Bank Profitability
  6. Summary
  7. Key Terms
  8. Review Questions
  9. Further Reading
  10. Notes
2. CHAPTER 2: Asset and Liability Management Committee (ALCO)
  1. Introduction
  2. ALCO Role and Functions
  3. ALCO Plan
  4. Summary
  5. Key Terms
  6. Review Questions
  7. Further Reading
  8. Notes
3. CHAPTER 3: Managing Bank Assets and Liabilities
  1. Introduction
  2. Managing Bank Assets
  3. Managing Bank Liabilities
  4. Summary
  5. Key Terms
  6. Review Questions
  7. Further Reading
  8. Notes
PART 2: MANAGING LIQUIDITY RISK AND INTEREST RATE RISK
1. CHAPTER 4: Liquidity Management
  1. Introduction
  2. Definition and Measures of Liquidity
  3. Determining Funding Needs
  4. Stress Tests
  5. Summary
  6. Key Terms
  7. Review Questions
  8. Further Reading
  9. Notes
2. CHAPTER 5: Managing Interest Rate Risk
  1. Introduction
  2. Types of Interest Rate Risk
  3. Interest Rate Gap Analysis
  4. Duration Analysis
  5. Basis Point Value
  6. Immunisation and Hedging Interest Rate Risk
  7. Net Interest Income Sensitivity Analysis
  8. Securitisation
  9. Summary
  10. Key Terms
  11. Review Questions
  12. Further Reading
  13. Notes
3. CHAPTER 6: ALM in Changing Market Conditions
  1. Introduction
  2. Lessons from the Global Financial Crisis
  3. From Stress Testing to Contingency Plan Execution
  4. ALM Strategy and Interest Rate Cycle
  5. Summary
  6. Key Terms
  7. Review Questions
  8. Further Reading
  9. Notes
4. CHAPTER 7: Case Studies
  1. Introduction
  2. Liquidity Risk: Royal Bank of Scotland Fails Stress Test (2016)
  3. Liquidity Risk: Lehman Brothers (2008)
  4. Continental Illinois National Bank's Electronic Cash Out (1984)
  5. Bank of New England's Silent Run (1991)
  6. Summary
  7. Key Terms
  8. Review Questions
  9. Further Reading
  10. Notes
APPENDIX A: Principles for Sound Liquidity Risk Management and Supervision
Index
End User License Agreement

List of Tables

Chapter 1
1. TABLE 1.1 Bank profitability ratios
2. TABLE 1.2 A three-stage view of asset and liability management
Chapter 2
1. TABLE 2.1 The purpose and scope of ALCO set by the Bank of England
Chapter 4
1. TABLE 4.1 Basel Committee on Banking Supervision reforms - Basel III
2. TABLE 4.2 Summary of Liability Categories and associated ASF Factors
3. TABLE 4.3 Summary of Asset Categories and Associated RSF Factors
Chapter 5
1. TABLE 5.1 Summary of gap and the change in the NII
2. TABLE 5.2 DGAP Summary
Chapter 7
1. TABLE 7.1 RBS projected consolidated solvency ratios in the stress scenario

List of Illustrations

Chapter 1
1. FIGURE 1.1 Scope of banking activities
2. FIGURE 1.2 An example of a balance sheet. From the ‘Interim Report 2016’ (Hang Seng Bank)
3. FIGURE 1.3 Condensed Consolidated Income Statements (Hang Seng Bank)
Chapter 2
1. FIGURE 2.1 Reporting for the ALCO
2. FIGURE 2.2 Expected liquidity and interest-rate gap: a snapshot profile
3. FIGURE 2.3 ALM breakdowns by product (or market) segment
4. FIGURE 2.4 ALM breakdowns by type of interest rate
5. FIGURE 2.5 Asset profile volume and average income spread
6. FIGURE 2.6 Business lines and average income spread
7. FIGURE 2.7 Asset-backed securities stock
8. FIGURE 2.8 Elements of a sound risk management system
Chapter 6
1. FIGURE 6.1 The global financial crisis timeline
2. FIGURE 6.2 Dynamic approach of ALM
3. FIGURE 6.3 The impact of interest rates on NIM was visible in Hong Kong in the years after the GFC

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Library of Congress Cataloging-in-Publication Data

Names: The Hong Kong Institute of Bankers, editor.

Title: Bank Asset and Liability Management / by The Hong Kong Institute of Bankers.

Description: Hoboken : Wiley, 2018. | Includes index. |

Subjects: LCSH: Asset-liability management. | Bank management. | BISAC: BUSINESS & ECONOMICS / Banks & Banking.

Classification: LCC HG1615.25 (ebook) | LCC HG1615.25 .B36 2017 (print) | DDC 332.1068/1–dc23

LC record available at https://lccn.loc.gov/2017049293

Cover Design: Wiley

Cover Images: Stuttgart Fountain and Palace © iStockPhoto.com/Rolf Weschke; techno background © polygraphus/Shutterstock; marble © rusm/iStockphoto

Preface

‘Bank Asset and Liability Management’ (BALM) is a module within The Hong Kong Institute of Bankers (HKIB) curriculum of Treasury Management. As part of the Certified Banker qualifications structure, the syllabuses are tailor made for learning and development of a banking career in Hong Kong and Mainland China. This module is focused on developing the tools to manage assets and liabilities as well as providing practitioners with the knowledge necessary for strategic execution to ensure a safe and effective composition of assets and liabilities to support a bank's business model.

Why is this important? Bank treasury needs to be able to understand the complexity of market conditions. The implementation of an Asset and Liability Management (ALM) strategy set by the Asset and Liability Management Committee (ALCO) and bank management is closely linked to a bank's ability to implement effective risk controls. These range from interest rate risk to liquidity risk, which are among the eight inherent risks under constant vigilance of banks and financial institutions.

This book Bank Asset and Liability Management aims to equip banking professionals with the necessary knowledge and tools to understand the complexity of changing market conditions and to apply their learning to manage ALM and take advantage of emerging opportunities.

The Hong Kong economy has been resilient against international financial crisis and has earned the highest AAA sovereign credit rating from Standard & Poor's since 2010, thanks in part to the strong standard of governance and a well-regulated and capitalised banking sector. Due to the cross-border nature and the growing size of financial intermediation activities vis-à-vis the size of our economy, the banking sector must remain vigilant against future financial shock. Hong Kong is now the world's 4th largest foreign exchange centre. Strong BALM is critical to timely and sound execution, especially during times of crisis.

This book is divided into two parts and seven chapters that delve deeply into the subject matter. Every effort has been made to ensure that policies and regulations discussed in this book are up to date and current as at early 2016. Students are advised to keep themselves up to date from the web sites of HKIB, the regulator Hong Kong Monetary Authority (HKMA) and the Bank for International Settlements. At the time of writing, the regulations relating to Fundamental Review of Trading Book (FRTB) and OTC Derivatives are still evolving.

The first part of this book starts with a background discussion of bank asset and liability management. Chapter 1 considers the role of ALM in managing bank profitability, ensuring liquidity and drafting financial statements. Chapter 2 looks at the role of the Asset and Liability Management Committee (ALCO) that every bank has, including its role and functions and how it manages liquidity and funding risk. Chapter 3 dives right into the subject matter by considering how banks manage their assets and liabilities.

The second part of this book starts on Chapter 4 with a discussion of liquidity management, its definition and the steps banks take to ensure they always have enough liquidity to cover their liabilities. Chapter 5 takes a deep dive into a key facet of ALM, the management of interest rate risk. Chapter 6 takes a step back by considering how banks can manage ALM when market conditions are changing and risks grow larger.

The final chapter in this book brings the discussion to a practical conclusion by considering a series of case studies to illustrate how weaknesses in ALM can result in significant financial loss and even bankruptcy.

This book includes detailed explanations, summaries, tables and charts to help industry professionals develop a sound theoretical framework for their work in the field. Both students and working professionals can benefit from this detailed work produced in collaboration with some of Hong Kong's most prominent professionals. Aimed at banking practitioners, and designed as an essential tool to achieve learning outcomes, this book includes recommendations for additional reading. A ‘Further reading’ list can be found at the end of each chapter to help readers expand their knowledge of each subject.

A number of people were integral to the development of this work. Among them it is important to highlight Mr Peter Wong Wai Man for his valuable insight and review on the syllabus and content of this book. Mr Wong is also the Executive Board Member of the Treasury Markets Association and the former Regional Director and Treasurer of AIA and is now a director at PwC. There are many others whose contributions have been of particular significance in the preparation of this essential reference for banking professionals. The information provided in the collection of Hong Kong Monetary Authority publications has been instrumental in developing much of the book.

The preparation would not have been possible without the help, advice, support and encouragement of all these people and dozens more. We would like to extend our sincere thanks to them all.

The Hong Kong Institute of Bankers