A Linear Programming Model for Assessing Asset-Liability Management in Banks

Abstract

Asset-liability management (ALM) may be defined as the simultaneous planning of all asset and liability positions for a bank, considering the different bank management objectives and the legal, managerial and market constraints, for the purpose of enhancing the value of the bank, providing liquidity, and mitigating interest rate risk (Gup and Brooks, 1993). An efficient asset-liability management system aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of the assets and liabilities as a whole, so as to earn a predetermined, acceptable risk/reward ratio. The framework of asset-liability management broadly covers the areas of interest rate risk, liquidity risk, exchange risk and credit risk. The present study proposes a linear programming model for asset-liability management, with profitability as the objective, and constraints based on liquidity and statutory requirements. The model was applied to a sample of banks operating in India, resulting in a recommended optimal asset-liability mix of the banks in the sample. Using these results, the study assessed the nature of asset-liability management of different bank groups, in terms of its implications on profitability, liquidity, and interest rate sensitivity.