Asset-Liability Committee (ALCO)

Written By:
Adiste Mae

What is an Asset-Liability Committee?

An Asset-Liability Committee or ALCO refers to managerial or board level employees who are assigned with the oversight and management of the assets and liabilities of the company with an end goal of generating returns.

It is with the committee’s management of these assets and liabilities that they are able to affect a change in the net earnings of the company.

In order to generate returns, it is ALCO’s job to mitigate risks such as interest rate risks and liquidity risks that result from a mismatch of the company’s assets and liabilities.

Ultimately, being one of the most important executive committees in the company, the ALCO must be able to make sure that the balance sheet of the company is robust and will stay that way for the long term.

Typically, ALCOs are found in companies that are in the business of lending money, banks, mortgage companies, or even credit unions.

They are most important in promoting communications within the company regarding issues that could potentially threaten the returns of the company in terms of interest rate fluctuations, liquidity, and risks.

Understanding the Role of Asset-Liability Committees (ALCO)

It is through financial planning and risk management that companies are able to reduce risks across the institution that are typically brought about by the world’s changing financial landscape.

Traditionally, the risks are managed separately.

But in the current landscape, all the relevant risks need to be continuously monitored and addressed.

The effective evaluation of the on-and-off-balance sheet risks of a company is communicated through MIS or Management Information Systems that is provided for by the members of the ALCO.

In order for banks to be able to deliver value to its internal and external stakeholders, members of the ALCO must be able to properly incorporate mainly the interest rate risk and liquidity into consideration.

Every company values the importance of liquidity, especially if the company is in the business of financing (bank, lending, mortgage or credit unions).

The goal of ALCO is to make sure that the company is liquid enough while they manage the spread of interest income and interest expense.

This is why the effective evaluation of on-balance and off-balance sheet items is very important because off-balance sheet items do not directly affect the financial position of the company, while on-balance sheet items obviously have a direct impact on the balance sheet because they are shown.

It is important for the Asset-Liability Committees to be able to effectively manage market risks tolerance and establish MIS.

This can be achieved when ALCO meetings are conducted every quarter.

The responsibilities of the members of the Asset-Liability Committee include the management of market risk tolerances, establish MIS reports, annually review and approve the liquidity and funds management policy, develop and maintain a contingency funding plan, and to review immediate funding needs and sources.

For ALCO to be able to effectively manage market risks tolerance and establish MIS reports, they must be able to develop and review certain activities that include Agreements on Borrowing and Repurchasing, Reports on Funding Uses and Sources, Adverse Scenario Analysis, Investment Portfolio Analysis, Interest Rate Risk Analysis, Asset and Liability Management, Comparisons on Budget and General Ledger or Income Statements, New Accounts, and Large Depositors.

In addition to the above, it is the ALCO’s responsibility to evaluate liquidity risk exposures to certain adverse scenarios that vary in probability and severity.

In some cases, ALCOs tend to hire third parties who are experts of the subject matter.

Special Considerations

The relationship between the strategies, procedures, and policies between ALCO and the objectives and risk tolerances of the company’s board must be translated articulately and understood by management.

After all, just like in investments and businesses for profit, the movement of the earnings of the company depends on the risk that they are willing to take.

The strategies are intended to set out the company’s liquidity management, communicate liquidity risk tolerances and clearly define the extent of how the key elements of fund management are centralized or delegated throughout the company.

The strategic matching of the company’s assets and liabilities ensure that they are able to operate efficiently for the long-term.

When an institution is efficient, they are also profitable and at the same time able to reduce risks.

The movement of cash flow is essential in the goals of ALCO.

As such, their activities and strategies must reflect greatly on several factors including asset liquidity, liabilities and operating cash flows that must meet the day to day or contingent funding needs of the company.

The policies can generally include guidelines on the limitation set on the composition of assets and liabilities of a company, and maintenance of a suitable liquid asset cushion.

It can also include creating a policy that looks at the ongoing basis or contingent liability scenarios of the relative reliance of funding sources, or the marketability of assets that are to be used as contingent sources of liquidity.

Asset-Liability Committee Example

There must be a resolution to be able to create an Asset-Liability Committee which should be executed by the executive board.

The ALCO consists of the chairman of the committee appointed by the executive board and at least seven or more members with a right to vote for a year.

Members without voting rights are appointed and presented to the chair who will also sit on the committee for 1 year.

Typically, an Asset-Liability Committee is composed of subcommittees such as the Balance Sheet Management Committee, Credit Risk Committee, Pricing Committee and the Funding Group.

Because risks are continuously monitored, ALCO meetings are normally held every two weeks.

During these meetings, they will have the authority to  be able to provide a resolution on matters should more than half of the voting committee be present during these meetings and vote in favor of the resolution.

When the committee votes in favor of a resolution, it is essentially binding to all the employees.

There is no single framework for ALCO across different organizations – each ALCO framework is unique.