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PRODUCTS - ALMAN (ALM/Risk Department)
How ALMAN assists the Interest Rate Risk (IRR) Manager
ALMAN will identify the appropriate strategy, which will depend on the current level of risk, the time frame, and the current interest rate environment, as a strategy for an expected increasing interest rate cycle will not be appropriate for a decreasing interest rate cycle.
Interest rate risk is the risk that the company will experience deterioration in its financial position as interest rates move over time.
ALMAN enables the IRR manager to identify, measure and monitor the following sources of interest rate risk:
Repricing Risk, which reflects the fact that assets and liabilities are of different maturities and are priced off different interest rates.
Basis Risk, which arises when there is an imperfect correlation in the adjustment of the rates earned and paid on different instruments with otherwise similar repricing characteristics. When interest rates change, these differences may give rise to unexpected changes in the cash flow and earnings spread between assets, liabilities and off-balance sheet instruments of similar maturities or repricing frequencies.
Optionality Risk, arising from the options embedded in the assets and liabilities and off-balance sheet portfolios. An option may be embedded within a portfolio, e.g. loans that give borrowers the right to prepay balances and deposits that give the depositor the right to withdraw funds prior to final maturity without penalties.
How ALMAN measures Interest Rate Risk
The following standard IRR reports are available in ALMAN:
ALMAN enables the IRR manager to identify, measure and monitor the following sources of interest rate risk:
Repricing Risk, which reflects the fact that assets and liabilities are of different maturities and are priced off different interest rates.
Basis Risk, which arises when there is an imperfect correlation in the adjustment of the rates earned and paid on different instruments with otherwise similar repricing characteristics. When interest rates change, these differences may give rise to unexpected changes in the cash flow and earnings spread between assets, liabilities and off-balance sheet instruments of similar maturities or repricing frequencies.
Optionality Risk, arising from the options embedded in the assets and liabilities and off-balance sheet portfolios. An option may be embedded within a portfolio, e.g. loans that give borrowers the right to prepay balances and deposits that give the depositor the right to withdraw funds prior to final maturity without penalties.
How ALMAN measures Interest Rate Risk
The following standard IRR reports are available in ALMAN:
| • | Gap report |
| • | Cumulative gap report |
| • | Interest sensitivity report |
| • | Balance sheet sensitivity report |
| • | Income statement sensitivity report |
| • | Rate spread report |
A myriad of stress testing facilities exist in ALMAN to provide information on the kinds of conditions under which the bank’s strategies would be most vulnerable.
Examples include:
Examples include:
| • | abrupt changes in the general level of interest rates, |
| • | changes in the relationships among key market rates (i.e. basis risk), |
| • | changes in the volatility of market rates. |
By modelling different strategies, ALMAN will enable the IRR manager to minimize risk while maximizing earnings and net worth. This is done by means of measuring the projected earnings for different product mixes, with strategies such as:
| • | Buying and selling assets |
| • | Changing liability structure and mix |
| • | Introducing new products (assets and/or liabilities) |
| • | Hedging |