Director’s Role in the ALCO Process
By James J. Clarke
Asset/liability management (ALM) is one of the most important elements in community banking success. ALM is often narrowly pigeonholed as interest-rate risk management, but this is only one aspect of balance sheet management. ALM should be driven by the institution’s strategic plan in the intermediate term and by the budget in the short run. Effective ALM must consider both profitability and risk. Too often, ALM is viewed simply as risk management, but whether your institution is public or mutual, ALM should incorporate the trade-off between risk and reward. Successful banks take risks, but effectively manage the balance-sheet risk through the ALCO. ALM should be profit-driven. Profit should be the focus of both public and mutual institutions. ALM is the process of managing the balance sheet to achieve an acceptable level of profit while operating within regulatory risk parameters and a risk profile acceptable to the board.
ALM is the direct responsibility of a committee referred to as the Asset/Liability Management Committee (ALCO). Some banks may use different terminology such as pricing committee, investments committee or finance committee. Best practices would suggest naming the committee ALCO. It is important for the board to understand the role of the committee, its membership and an effective agenda.
The committee’s job is to manage assets, liabilities and capital along with managing balance sheet risk. The committee has a number of responsibilities as enumerated below:
• Manage the balance sheet to achieve an optimal balance between risk and reward.
• Allocate cash and fund assets.
• Insulate the bank from interest-rate risk.
• Keep the board informed as to the total risk profile of the bank with a quarterly risk profile report. Prepare the board for audits by their primary regulator.
Before continuing, it is important to distinguish the role of the board from the role of management in the ALM process. The role of management is to manage the balance sheet on a daily basis. This involves both the selection of earning assets and appropriate funding sources. Senior management is also responsible for managing balance-sheet risk on an ongoing basis.
The role of the board is to establish parameters for balance-sheet management. These parameters are usually included in policies. The board has its impact in adopting policies; for example, funds management, liquidity, interest-rate risk and investment policies. Furthermore, the board has the responsibility to monitor risk. Given the separation of duties, most banks would be best served with two committees: A board ALCO meeting quarterly, and a management ALCO meeting monthly or weekly.
The composition of the ALCO may differ among institutions, but there ought be some basic standards. In establishing a board ALCO, I would suggest three to five members, preferably individuals with some financial background. The management ALCO may encompass a wide range of senior management, but should at least include the following:
• CEO – the top executive officer;
• CFO – the top financial officer, regardless of title;
• Controller – this individual, along with the CFO, will be responsible for providing key information;
• Senior loan officer – the committee will need to consider loan decisions in terms of volume and pricing; and
• Senior retail officer – the committee will need to make deposits in terms of volume and price.
Both the board and management ALCO should be focused on the critical issues related to balance-sheet decisions; therefore, committee structuring is important.
A sound agenda is critical for a smooth-flowing process. If the institution has a separate board and management committee, the agenda will be different for these committees.
James J. Clarke (JJClarke2@aol.com) is principal of Clarke Consulting, based in Villanova, Penn. He serves on the board of a mutual savings bank and a mutual fund, and has served on the board of a publicly held bank. He is also a frequent speaker for the Connecticut Bankers Association.