In light of shifting regulatory, technological and market forces, financial institutions are revisiting their asset liability management strategies. These institutions are increasingly seeking a more holistic approach to balance sheet management. This is based on their short-term liquidity risk as well as risk arising from their long-term asset and liability management (ALM). A few key external forces are driving this evolution: regulatory pressures, market dynamics and rapid technological developments.

Regulatory pressures

Due to the 2008 financial crisis – in essence a liquidity crisis – regulators like the US Federal Reserve have been more actively supervising financial institutions. In particular, regulators are looking at how banks are managing risks across their portfolios. As part of this, we've seen a drastic rise and constant evolution in regulatory requirements for banks and insurance companies across the globe.

Along with new and still evolving liquidity risk management requirements and related reporting requirements, financial institutions are facing:

• An evolution of guidelines and scope for management of the interest rate risk in the banking book (IRRBB).
• Requirements to assess net interest income (NII) impact within regulatory stress testing exercises.
• Increased scrutiny of underlying model management.
• Heightened supervisory expectations around adoption of the Basel principles for effective risk data aggregation and risk reporting (BCBS 239).

Market dynamics

Financial institutions are facing pressure on profit margins from multiple angles. The financial services business is growing more and more competitive, with new entrants offering innovative products and services tailored toward an increasingly tech-savvy population. They are also facing rising costs caused by higher capital requirements and higher quality liquidity reserve requirements. These forces require banks to more effectively manage asset allocation across their portfolios to improve returns on capital while still maintaining adequate liquidity.

Balance sheet management has been further complicated by historically low interest rates. This strains net interest margins and makes effective interest rate risk management even more important. The possibility of negative rates further challenges asset liability management techniques and models that may not be designed to accommodate such extreme inputs.

Technological developments

With the rapid evolution in IT technology, financial institutions can achieve performance and scalability capabilities unobtainable until now. These advancements allow them to analyze a wider range of scenarios and input assumptions. And they enable richer, more granular analytical asset liability management techniques.

The last decade saw the rise of cloud services and the evolution of application development and deployment best practices (e.g., continuous integration, continuous delivery). These changes have ushered in faster and cheaper delivery of analytical solutions with new functionalities and highly flexible scalability. Banks are increasingly eager to use these emerging capabilities to better manage total assets and liabilities.

The road ahead for asset liability management strategies

Short-term economic conditions and long-term technology and regulatory oversight trends are changing how financial institutions address balance sheet management and liquidity risk. This is leading asset liability management techniques to become much more granular and dynamic.

Analysis of a specific set of ALM and liquidity risk measures over a limited range of scenarios is evolving into broader, integrated balance sheet management. This is a more dynamic paradigm. It allows bank management to use cash flow projections in a unified and fully integrated way. The new approach addresses asset and liability management, liquidity management, credit risk, market risk, balance sheet profitability, capital planning and stress testing analysis.

To maximize profitability under regulatory and policy constraints, banks have started to use modern analytical tools to help determine their optimal asset allocations, balance sheet compositions and liquidation strategies. This is no easy task. But financial institutions can expect to achieve incremental operational and financial improvements on their journey. Given today's challenging environment, these advancements in asset liability management strategies will prove critical in maintaining competitiveness.

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