Liquidity and Asset Liability Management

Flashcards covering the fundamentals of liquidity, asset-liability management, interest rate risk, and gap analysis for commercial banking.

Asset Liability Management (ALM)

The practice of balancing a bank's current and long-term potential earnings with the need to maintain adequate liquidity and appropriate interest rate exposures.

Liquidity Management

A strategy within a bank that should balance risk-taking with returns, ensuring the institution can meet sudden or unexpected withdrawals of deposits.

Asset Management

A strategy for meeting liquidity needs by utilizing the most liquid near-term assets.

Liability Management

A strategy to meet liquidity needs by using outsourced sources such as borrowings at a discount window, Fed funds, and other borrowing facilities.

Loan Deposit Ratio

A liquidity metric representing how much of a bank's deposits are being loaned out in the form of loan products.

Hold-to-Maturity (HTM)

An accounting treatment for investment portfolios where securities must be held for their full term (e.g., $10$ years) and are not available to be sold for liquidity.

Reserve Requirement

A central bank regulation set by the Federal Reserve Bank that determines the minimum amount of liquid assets a bank must hold to handle sudden deposit withdrawals, consisting of cash held in the bank or deposits at the Federal Reserve.

Net Transaction Deposits

The total transaction accounts minus the amounts due from other depository institutions, excluding savings and time deposits, used to calculate reserve requirements.

Fed Funds

A tool for managing liquidity where banks sell excess liquidity overnight to a correspondent bank or purchase liquidity if needed.

Repo (Repurchase Agreement)

A short-term, generally overnight agreement where a bank trades government securities for temporary liquidity without realizing permanent gains or losses on the income statement.

Discount Window

A collateralized line of credit reserved for banks to access liquidity from the central bank.

Upside Risk

In interest rate management, this refers to the risk associated with interest rates going up.

Downside Risk

In interest rate management, this refers to the risk associated with interest rates going down.

Duration Risk

The risk that a bond, fixed-income investment, or loan will lose value due to changes in interest rates, characterized by an inverse relationship where value decreases as rates rise.

Net Interest Income (NII)

The difference between interest income and interest expense, which is directly correlated to changes in interest rates and the composition of assets and liabilities.

ALCO (Asset Liability Committee)

A committee within a bank that evaluates pricing, product offerings, liquidity, and interest rate sensitivity with a holistic view of the bank's performance.

Time Deposit (CD)

A fixed-maturity deposit product, such as a Certificate of Deposit, that provides a fixed rate for a set period.

SOFR and Ameribor

The new interest rate indexes that are being phased in to replace the former index known as LIBOR.

Interest Sensitivity

The impact of interest rate changes in relation to the cost of deposits or the return on assets.

Dollar Gap Ratio

A key measure used to assess interest rate exposure, calculated as Rate Sensitive Assets ($RSAs$) minus Rate Sensitive Liabilities ($RSLs$) as a percent of total assets.

Rate Sensitive Assets (RSAs)

Assets, such as portions of the investment portfolio and loans, that reprice within a certain timeframe.

Rate Sensitive Liabilities (RSLs)

Liabilities, such as certain deposit costs and borrowings, that reprice within a certain timeframe.

Positive Gap

A state where a bank has more Rate Sensitive Assets than Rate Sensitive Liabilities, leading to increased Net Interest Income when interest rates rise.

Negative Gap

A state where a bank has more Rate Sensitive Liabilities than Rate Sensitive Assets, leading to a decline in Net Interest Income when interest rates rise.