Asset Liability Management

What is Asset Liability Management?

An asset/liability management is the process that is defined as paying off liabilities from assets and cash flows of a company, and its proper implementation reduces the risk of loss for not paying the liabilities on time. Companies must ensure that assets and cash flows are there available on time when needed to avoid additional interest and penalties. Better use of asset/liabilities management helps in making an additional business profit.

Techniques Used for Asset Liability Management

1) Gap Analysis in Asset and Liability

A gap is defined as the difference between Rate sensitive assets and Rate Sensitive liabilities.

GAP = Rate Sensitive Asset – Rate Sensitive Liabilities
GAP Ratio = Rate Sensitive Asset/ Rate Sensitive Liabilities

2) Asset Coverage Ratio

Another important ratio to manage the asset and liabilities is the asset coverage ratioAsset Coverage RatioAsset Coverage Ratio is a risk analysis multiple that depicts the company’s ability to repay the debt by selling off the assets and outlines how much of the monetary and tangible assets are available against the debt. It helps an investor to predict the future earnings and gauge the risk involved in the investment.read more, which determines the number of assets available to pay off the debts.

Asset Coverage Ratio = ((Total asset- intangible asset) – (current liabilities- short term debt))/total debt

The higher the asset coverage ratio, the more asset, the company is having to pay off its debt. Companies should at least have this ratio as more than 1.

Examples of Asset Liability Management in Different Industries

The following are examples of different industries.

Asset-Liability-Management

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Source: Asset Liability Management (wallstreetmojo.com)

#1 – Banking Industry

Banks are the financial intermediary between its customers and future endeavours. Banks take a deposit from their customers for which they are obliged to pay interest. From these deposits, they provide loans for which they receive interest income. Banks need to implement strong asset-liability management to ensure between net interest income and to ensure that it can pay off its customer deposits at any given time.

#2 – Insurance Companies

Insurance companies provide two types of insurance: life and non-life. Non- life insurance is property and vehicle insurance. Insurance companies receive payment from other parties, but they are liable to pay some lump sum amount as and when required. So they will have to make sure that at any time, they are having the funds available to pay off these liabilities.

#3 – Benefit Plan

Benefit Plans such as future retirement plans take some funds out of employees’ salaries and then, in the future, pay this amount with the applicable rate at the time of retirement. These groups need to make sure that they have funds to meet these liabilities.

Benefits

Following are the benefits:

Limitation

Below point is the limitation:

  • There are other criteria which need to be looked upon to check the risks of a company apart from an asset-liability management
  • It can be misleading sometimes.
  • Sometimes having risk is better because high risk gives higher returns.

Important Points to Note

  • Its objective is to manage risk, not to eliminate risk.
  • It is the process of taking a decision to control risks and stabilizing the system by balancing assets and liabilities.
  • Companies should have adequate assets to pay off its liabilities whenever due.
  • Companies can use the Gap analysis and Asset Coverage Ratio to quantify this management.
  • In the banking industry, It is used to address the risk of asset-liability mismatch because of either interest rate or liquidity risk.

Conclusion

Asset liability management is an important concept that is being used in various industries, primarily in the banking and insurance industry. An effective asset management policy framework can increase the profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more of banks by increasing net interest income.

A better view can be seen as a coordinated process of combining balance sheet itemsBalance Sheet ItemsAssets such as cash, inventories, accounts receivable, investments, prepaid expenses, and fixed assets; liabilities such as long-term debt, short-term debt, Accounts payable, and so on are all included in the balance sheet.read more into the right mix. The gist of the technique that companies should have adequate assets to pay off its liabilities Asset liability management is a systematic approach that can provide protection against the risks which can arise from the asset-liability mismatch.

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