15 July 2014

Training Manager's Guide to Treasury & ALM

Continued economic instability and a raft of banking regulation introduced in recent years means that both the Treasury and ALM divisions of banks have well and truly been brought to the forefront. Find out what the skills gaps are for those working in this area

A bank’s Treasury and asset liability management (ALM) functions are intrinsically linked due to the challenging nature of its balance sheets and the fact that regulatory standards must be upheld.

The two departments are almost always combined into one function but where they are separate they will collaborate in managing interest rate, liquidity and currency risk. However, ALM’s focus is on internal funding, liquidity risk analysis and funds transfer pricing, whereas Treasury concentrates on market access and external funding.

Important to know right now...

Continued economic instability and a raft of banking regulation introduced in recent years means that both the treasury and ALM divisions of banks have well and truly been brought to the forefront.

Questions are being raised as to whether current funding models remain fit for purpose in the current financial landscape, while bank boards are becoming increasingly forward-looking as they develop bank strategy over the longer term, something the treasury will play a vital role in. Strategic ALM will also feature on many forward-thinking banks’ agendas as they move towards an integrated approach to bank balance sheet risk management that considers asset origination and liabilities rising from a single unitary perspective.

As with so many areas of finance, regulation will play a significant role in ALM and treasury management over the coming years. The Basel III international bank supervisory regime will be rolled out worldwide in 2019, putting more stringent demands on banks with regards to their capital and liquidity levels. In the US the enhanced regulatory system, Dodd-Frank, will affect how banks manage risk. There is also the liquidity risk and the liquidity coverage ratio (LCR): the new liquidity metric requirement for all regulated banks to consider.

Alongside all of these changes, it is also important to remember that many of the historic challenges which have faced treasuries such as maximising capital efficiency, liquidity modelling, collateral management and improving the risk return ratio cannot be neglected.

Need to know key terms...

Also known as maturity transformation , liquidity mismatch is when banks take short-term sources of finance, for example savings deposits, and turn them into long-term lending such as mortgages.

Leverage is a general term for an investment that is made using borrowed funds. A bank’s balance sheet, for example, will typically comprise 10%-20% equity capital with the remainder being debt finance. Various financial tools, are used to increase an investment’s potential return.

The ‘gap’ refers to the difference between a bank’s interest-sensitive liabilities and its interest-sensitive assets. If liabilities exceed assets then the gap is considered negative but if assets exceed liabilities the gap is positive.

Trading Liquidity refers to an asset’s ability to be converted into cash quickly or the degree to which it can be bought or sold in the market without having too significant an impact on an asset’s price. ‘Liquid assets’ can be bought and sold easily.

Funding Liquidity is the extent to which funds can be borrowed in the market on a rolling basis.

Risk management initially involves identifying and analysing the level of risk which comes with any investment and assessing how likely losses are. The second stage of effective risk management is working out a way to handle any risks identified.

Risk metrics are the procedure for quantifying risk levels. Volatility, duration and probability are all examples of risk metrics.

Balance sheet risk includes interest rate, FX and liquidity risks which arise from a bank’s core activities.

The treasury operating model refers to how the bank chooses to operate its treasury department, including its structure, what processes are followed and how it achieves its aims.

Liability strategy , or liability management as it is sometimes known, refers to the use of liabilities to facilitate lending and allow for balanced growth. Banks have been actively managing liabilities since the 1960s.

Who works in treasury and ALM?

The head of treasury works within the senior finance team and is tasked with actively managing the organisation’s cashflow and balance sheet as well as understanding and ensuring the company’s liquidity needs.

The chief risk officer has overall responsibility for managing a bank or company’s risk exposure levels.

The chief financial officer is in charge of setting and working towards the bank’s overall financial objectives by developing and implementing financial policies and procedures. They often have overall responsibility for ALM or share it with the treasury.

Key challenges and common skills gaps

With an increased focus on treasury and ALM actions comes a number of new challenges for people working in these areas to overcome.

Skills gaps which have been identified, and may require specialist training to resolve include liquidity data analysis, which poses an even bigger challenge given the sheer amount of data banks have access to. Simple spreadsheets are a thing of the past and banks must have ways of recording and analysing the information available to them if they are to make appropriate decisions based on it.

Stress testing is another area which needs to be a focus for many banks. According to research by PricewaterhouseCoopers, regulatory stress testing is emerging as one of the most powerful tools for determining bank capital levels. However, a survey by the financial organisation found that many banks are underprepared for tougher regulatory stress testing and have inadequate people resources dedicated to stress tests.

Last but certainly not least, liquidity modelling is posing a significant challenge to banks. According to KPMG, since 2008, banks have become much better at predicting market and credit risk; however, liquidity modelling is still proving very tricky given the speed at which the market shifts and the demands of new liquidity regulations. Banks need to develop processes for measuring and monitoring liquidity risk and many staff will need significant training and guidance in this area.

Euromoney Training run a number of Treasury & ALM courses which are designed to help address these challenges and skills gaps. Take a look today .

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