Asset liability management optimisation : a practitioner's guide to balance sheet management and remodelling / Beata Lubinska.

ABOUT THE AUTHOR
BEATA LUBINSKA is a Founder of BL Advisory & Consulting, a boutique firm based in London. Previously, she has worked in senior positions in a number of financial services companies such as GE Capital, Deloitte, Standard Chartered Bank, and MeDirect Group in London, where her focus was mainly on Interest Rate Risk in the Banking Book (IRRBB), Market Risk, Balance Sheet Management, and Funds Transfer Pricing. She has over 16 years of practical experience developed in the Asset Liability management space gained both in Milan and London. Beata is also a faculty member at The Certificate of Bank Treasury Risk Management, where she teaches optimisation techniques in Asset Liability Management. She holds a PhD in Finance from Wroclaw University of Economics.

TABLE OF CONTENTS
Foreword ix

About the Author xi

Introduction xiii

Chapter 1 ALM of the Banking Book 1

The Role of Asset Liability Management in Commercial Banks 1

Overview of Financial Risks Existing in the Banking Book 7

Regulatory Requirements – Basel III 13

Capital Requirements According to Basel III/CRD IV 17

Selective Review of the Literature Related to ALM and Integrated Management of the Interest Rate Risk and Liquidity Risk in Commercial Banks 19

Chapter 2 Methods of Measurement and Management of the Interest Rate Risk and Liquidity Risk 23

Interest Rate Risk in the Banking Book – Measurement and Management 24

Exposure to Short-Term Interest Rate Risk – Maturity Gap Analysis 24

Maturity Gap Analysis from the Economic Value Perspective 33

Liquidity Risk in the Banking Book – Measurement and Management 41

Short-Term Liquidity Management Principles 45

Medium Long-Term Liquidity – The Principles of Structural Liquidity Management 46

The Role of Funds Transfer Pricing in Banks 50

Pricing of Different Products in the Banking Book 54

Behaviouralisation Concept in FTP 57

Chapter 3 Customer Behaviour and Its Impact on Interest Rate and Liquidity Risk 61

Significance and Impact of Behavioural Issues in the Banking Book 61

Modelling of Customers’ Deposits – Liabilities Side 63

Balance Sensitivity Modelling 68

Modelling of Loans with Early Redemption Optionality –Assets Side 70

Statistical Prepayments 70

Financial Prepayments 71

Chapter 4 Formulation of the Optimisation Process and Articulation of the Decision Model 73

The Optimisation Method Applied to the Banking Book 74

Introduction of the Optimisation Concept 75

Definition of the Initial Banking Book Profile 79

Building the Objective and Constraint Functions in the Optimisation Process 81

The Importance of Model Sensitivity Analysis 96

Definition of the Sensitivity Parameters for the Optimisation Model 98

‘Significant Changes in Interest Rates’ Scenario 98

Changes in the Initial Proportions of the Asset Base 100

Changes in the Output of the Deposit Characterisation Model – Balance Volatility, Balance Sensitivity, and Average Life of the Product 100

Introduction of the CPR into the Model 100

Chapter 5 Practical Example of the Optimisation Process and Quantification of the Economic Impact under Base and Stress Scenarios 101

Case Study: Economic Impact from the Optimisation Model under Baseline and Sensitivity Scenarios for Bank 1 102

Case Study: Economic Impact from the Optimisation Model under Baseline and Sensitivity Scenarios for Bank 2 114

Conclusions 125

Appendix 1 Details of the Analysis Performed for Bank 1 129

Appendix 2 Details of the Analysis Performed for Bank 2 157

Bibliography 209

Index 213

An advanced method for financial institutions to optimize Asset Liability Management for maximized return and minimized risk

Financial institutions today are facing daunting regulatory and economic challenges. As they manage bank regulation and competition, institutions are also optimizing their Asset Liability Management (ALM) operations. The function of the ALM unit today goes beyond risk management related to the banking book into managing regulatory capital and positioning the balance sheet to maximize profit. Asset Liability Management Optimization: A Practitioner's Guide to Balance Sheet Management and Remodelling offers a step-by-step process for modeling and reshaping a bank's balance sheet. Based on the author's extensive research, it describes how to apply a quantifiable optimization method to help maximize asset return and minimize funding cost in the banking book.

ALM ranks as a key component of any financial institution's overall operating strategy. Now, financial professionals can use an advanced solution for optimizing ALM. This book takes a closer look at the evolving role of the ALM function and the target position of the banking book. It provides strategies for active management, structuring, and hedging of a bank balance sheet, while also exploring additional topics related to ALM.

A description of the Funds Transfer Pricing (FTP) process related to a bank’s target position
Detailed examinations of interest rate risk in the banking book (IRRBB)
Discussion of Basel III regulatory requirements and maturity gap analysis
Overview of customer behavior, along with its impact on interest rate and liquidity risk
Practical spreadsheet models (NII sensitivity and EVE volatility IRRBB model, simplified optimization model for minimization of average funding cost for a bank and an example of behavioral model for Non-Maturing Deposits)
Explorations of model risk, sensitivity analysis, and case studies
The optimization techniques found in Asset Liability Management Optimization can prove vital to financial professionals who are tasked with maximizing asset return and reducing funding costs as a critical part of business objectives.