Asset/Liability Management

A technique companies employ in coordinating the management of assets and liabilities so that an adequate return may be earned.

Also known as "surplus management."

Investopedia Says:
By managing a company's assets and liabilities, executives are able to influence net earnings, which may translate into increased stock prices.

Related Links:
Learn this easy-to-understand technique of analyzing a company's financial statements and reports. Introduction To Fundamental Analysis
Learn what it means to do your homework on a company's performance and reporting practices before investing. Advanced Financial Statement Analysis

Active management of a bank's Balance Sheet to maintain a mix of loans and deposits consistent with its goals for long-term growth and risk management. Banks, in the normal course of business, assume financial risk by making loans at interest rates that differ from rates paid on deposits. Deposits often have shorter maturities than loans and adjust to current market rates faster than loans. The result is a balance sheet mismatch between assets (loans) and liabilities (deposits).

The function of asset-liability management is to measure and control three levels of financial risk: Interest Rate Risk (the pricing difference between loans and deposits), Credit Risk (the probability of default), and Liquidity Risk (occurring when loans and deposits have different maturities).

A primary objective in asset-liability management is managing Net Interest Margin that is, the net difference between interest earning assets (loans) and interest paying liabilities (deposits) to produce consistent growth in the loan portfolio and shareholder earnings, regardless of short-term movement in interest rates. The dollar difference between assets (loans) maturing or repricing and liabilities (deposits) is known as the rate sensitivity Gap (or maturity gap). Banks attempt to manage this asset-liability gap by pricing some of their loans at variable interest rates.

A more precise measure of interest rate risk is Duration which measures the impact of changes in interest rates on the expected maturities of both assets and liabilities. In essence, duration takes the gap report data and converts that information into present-value worth of deposits and loans, which is more meaningful in estimating maturities and the probability that either assets or liabilities will reprice during the period under review. Besides financial institutions, nonfinancial companies also employ asset-liability management, mainly through the use of derivative contracts to minimize their exposures on the liability side of the balance sheet. See also Dynamic Gap; Gapping; Liquidity; Matched Maturities; Mismatch; Negative Gap; Positive Gap; Refinance Risk; Reinvestment Risk; Repricing Opportunities; Static Gap; Zero Gap.