Financial Risk Management in Banking: The Theory & Application of Asset & Liability Management

Table of Contents
List of Figures
List of Tables
Introduction
Chapter 1: What Is Asset and Liability Management?
	1.1 The Risk and Return Tradeoff in ALM
	1.2 The Goal of ALM
	1.3 Types of Risk
	1.4 Which Risks Cause Banks to Fail?
	1.5 Financial Organization Structure: Who Does ALM?
	1.6 The ALM Process
	1.7 The Characteristics of a Successful Asset and Liability Manager
	1.8 Take-Home Messages of This Book
	1.9 Summary
Chapter 2: The Nature of Risk, Return, and Performance Measurement
	2.1 What Is Risk?
	2.2 What Is Return?
	2.3 Shareholder Value Added
	2.4 Case Study on Profitability Measures
	2.5 Distinction Between SVA and Portfolio ROE
	2.6 Summary
Appendix 2A: Detailed Calculation of SVA Cash Flows
Chapter 3: Capital Regulation
	3.1 Foundations of Banking Safety and Soundness
	3.2 Capital Regulation Replaces Regulation Q
	3.3 Primary Capital: A Prescription for Higher Risk
	3.4 The Desire to Level the International Playing Field
	3.5 Risk-Based Capital: Salvation or Panacea?
	3.6 Risk-Based Capital: Illustrative Example
	3.7 Shortcomings of Risk-Based Capital
	3.8 Consequences of RBC Standards
	3.9 Administering the RBC Standards
	3.1 Summary
Chapter 4: Using Market Signals in Loan Pricing and Capital Allocations
	4.1 One Fundamental Problem with Banking
	4.2 Use of Market Signals in Capital Management
	4.3 Objections to and Disadvantages of Using Market Capital Signals
	4.4 An Alternative Approach for Market Capital
	4.5 Capital Allocations
	4.6 Some Observations on the Standard Deviation Method
	4.7 Establishing a Hurdle Rate on Economic Capital
	4.8 Access to New Capital
	4.9 Issues in Implementing Market Capital Measures
	4.1 How Not to Implement a Market Approach
	4.11 Summary
Appendix 4A: Comments on the Cost of Capital
Chapter 5: Interest Rate Risk Overview
	5.1 Target Accounts: An Example of Multidimensionality
	5.2 Case Study on Interest Rate Risk Management: The Problem
	5.3 Discussion of Case Study Results
	5.4 The Traditional Priorities of Some Important Constituencies
	5.5 The Bond Analogies
	5.6 A Review of All Possible Interest Rate Risk Strategies
	5.7 Interest Rate Risk and the Cost of Bankruptcy
	5.8 The Interest Rate Risk “Safety Zone”
	5.9 Summary
Appendix 5A: Is Interest Rate Risk Diversifiable?
Appendix 5B: The Relationship Between the Interest Rate Volatility of Net Interest Income and the Market Value of Equity
Appendix 5C: Derivation of the Hedging Conditions for the Interest Rate Risk Target Accounts
	5C.1 Equations for the Market Value of Equity Target
	5C.2 Equations for the Economic Equity Ratio Target
	5C.3 Equations for the Net Interest Income Target
Chapter 6: Interest Rate Risk Mismatching and Hedging
	6.1 Introduction to the Yield Curve
	6.2 Example Calculation of Implied Forward Rates
	6.3 Interest Rate Mismatching Case Study
	6.4 Criteria for Interest Rate Mismatching
	6.5 To Mismatch or Not to Mismatch?
	6.6 Hedging Balance Sheet Mismatches
	6.7 Hedging with Financial Futures
	6.8 Effects of a Futures Hedge on the Bank’s Financial Results
	6.9 Illustrating a Hedge Analysis at an ALCO Meeting
	6.1 Hedge Simulation with Bank Forecast Higher than Implied Forward Rates
	6.11 Historical Simulation Using Actual Futures and Spot Rates
	6.12 A Comment on Evaluating Hedge Performance and “Back Seat” Drivers
	6.13 Summary
Appendix 6A: Detailed Results of Historical Futures Analyses
Chapter 7: Interest Rate Risk Analyses: Gap Analysis and Simulation Models
	7.1 Objectives of Interest Rate Risk Analytical Techniques
	7.2 Gap Analysis
	7.3 Shortfalls of Gap Analysis
	7.4 Uses for Gap Analysis
	7.5 Simulation Modeling: The Brute Force Approach
	7.6 A Simulation Model Specification for the Case Study Example
	7.7 The Concept of “Securities” in Simulation Models
	7.8 Specifications for Forecast Assumptions
	7.9 Solving the Model
	7.1 Portfolios as “Tractors”
	7.11 Displaying the Simulation Results
	7.12 A Look Inside the Solved Model
	7.13 Some Comments on Data Feeds and Interfaces
	7.14 On Developing In-House Simulation Software
	7.15 Summary
Appendix 7A: Some Thoughts on Implementing and Using Simulation Software
Chapter 8: Interest Rate Risk Analyses: Duration
	8.1 Introducing Interest Rate Elasticity: Duration Incognito
	8.2 Duration Calculations Made Easy
	8.3 From Duration to Interest Rate Elasticity
	8.4 Application of IRE Analysis to Case Study Example
	8.5 “HELP! I Didn’t Understand the Duration/IRE Equations!”
	8.6 Summary
Appendix 8A: Duration Intuition and Bond Immunization
Appendix 8B: Mathematical Derivation of the IRE Equation
Chapter 9: Interest Rate Risk Characteristics of Bank Products
	9.1 Prime-Based Loans: An Example of Short-Term Spread Risk
	9.2 The Money Market Deposit Account
	9.3 The Need for a “Generic” Long-Term Tractor in ALM
	9.4 Demand Deposits
	9.5 Cash and Due From Bank Balances
	9.6 Mortgage Loans
	9.7 Incorporating Prepayment Risk into ALM Analyses
	9.8 Other Option Features of Bank Products
	9.9 Summary
Appendix 9A: A Primer on Option Pricing
Chapter 10: Credit Risk and Other Risk Factors
	10.1 The Effects of Asset Quality on Bank Borrowing Spreads
	10.2 Credit Risk and Shareholder Value
	10.3 Diversification of Credit Risk
	10.4 Credit Risk Portfolio Management
	10.5 Measuring the Diversification of the Loan Portfolio
	10.6 Collateral and Credit Risk
	10.7 Stock Market Risk
	10.8 Foreign Exchange Risk
	10.9 Measuring Foreign Exchange Risk
	10.1 Summary
Appendix 10A: An Options Theory Approach to the Value of Bank Debt and Equity
Appendix 10B: Pricing Risky Loans and the Bank’s Own Cost of Funds
Appendix 10C: Binomial Option Pricing Approach to the Bank’s Own Credit Risk
Appendix 10D: Quantifying the Effects of Diversification on Loan Portfolios
Chapter 11: Liquidity Analysis
	11.1 What Is Liquidity Risk?
	11.2 A Simple Balance Sheet Model of Liquidity
	11.3 Balance Sheet Liquidity Characteristics
	11.4 Managing Liquidity Risk: Perceptions and Reality
	11.5 Measuring Liquidation Cost Risk
	11.6 Controlling Liquidity Risk and the Safety Zone
	11.7 Diversification of Funding Sources
	11.8 The Contingency Planning Process
	11.9 Summary: Liquidity Risk and Shareholder Value
Appendix 11A: Just What Is the “Liquidity Premium” Anyway?
Appendix 11B: The Cost of Bankruptcy and Liquidation Costs
Appendix 11C: Liquidity in the Banking Industry
Chapter 12: Asset Securitization and Shareholder Value
	12.1 Asset Securitization: An Overview
	12.2 The Risk-Based Capital Ratio Impact on Originators and Buyers of Securitized Assets
	12.3 Securitization of Mortgage Loans
	12.4 Securitization of Other Assets
	12.5 Securitization and Capital Ratios From a Shareholder Value Perspective
	12.6 The Impact of Securitization on the Cost of Funds
	12.7 The Costs and the Process of Securitization
	12.8 Shareholder Value and Securitization: A Summary
Chapter 13: Profitability Measurement
	13.1 Guiding Principles
	13.2 Components of the Profitability System
	13.3 Budgeting, ALM, and Shareholder Value
	13.4 Cost Allocations
	13.5 A Cost Allocation Strategy
	13.6 Internal Funds Transfer Pricing
	13.7 Credit Allocations
	13.8 Capital Allocations
	13.9 Summary
Appendix 13A: Cost Allocation Case Study
Appendix 13B: Profitability Case Study
Chapter 14: Transfer Pricing
	14.1 Objectives of Transfer Pricing
	14.2 Overview of "Matched-Maturity" Transfer Pricing
	14.3 Advantages of the Matched-Maturity Transfer Pricing Method
	14.4 Selecting a Transfer Pricing Yield Curve
	14.5 Target versus Actual Credit Rating of the Bank
	14.6 Applying the 80/20 Rule to Transfer Pricing
	14.7 Use of Guaranteed Product Spreads
	14.8 Advantages and Disadvantages of the 80/20 Rule
	14.9 Prepayment Risk
	14.1 The Liquidity Commitment Spread
	14.11 Spread or Basis Risk
	14.12 A Survey of Transfer Pricing Adjustments
	14.13 Transfer Pricing Items Without Maturities: DDA and Equity
	14.14 Hedging Strategy for the Large Transaction Book
	14.15 Summary
Chapter 15: Putting It All Together
Bibliography
Index