The Asset Liability Committee, ALCO, is often best characterized as observers of the margin rather than controllers of margin behavior. Why, after all the meetings, sophisticated computer software, consultants and regulatory pressure, do ALCOs fail management? Because unlike a financial institution failure, it continues to function, it simply just does not make a difference. There is motion with no progress.
As providers of community bank and credit union planning software and consulting services for over 40 years, it is our mission to help our clients make the entire planning and management process both efficient and effective. To that end, we conduct ongoing research into the challenge of building an effective ALCO.
We have been able to identify three reasons for ALCO failure:
1) Unclear purpose
2) Wrong tools
3) Wrong people
In the first part of this series, we will be addressing the issue of having an unclear purpose.
Clarity of Purpose
To quote Alice in Wonderland’s Cheshire Cat "if you don’t know where you are going, then any road will take you there." Does your community bank's ALCO have a destination or goal? While developing the goal, the first controversy we usually meet is whether the ALCO is limited to margin issues, or should it deal with decisions related to the entire institution? As we talk to bankers, we find that many ALCO meetings become loan meetings; others complain that they become embroiled in complex investment products. The largest segment of ALCO’s review their gap reports, discuss data inaccuracies, and review rates then adjourn.
The first step toward creating an effective ALCO is to define its goals and objectives. Why are we here? What is our purpose? How will we know we are truly effective? What is asset-liability management anyway? How do we do this job? Who should be on this committee? What resources do we have available to us?
Once the strategic issues are resolved, other questions should be considered. What is the best margin we can achieve in this environment? Most institutions would gladly take a 5% margin, but it is probably impossible in their market, in this environment. Other considerations include calculating the required margin. There is a minimum margin that can be computed by adding capital formation requirement, dividends, net overhead, loan losses and taxes, i.e., all those cash flows the margin must support. These considerations help us quantify the goals and even suggest strategies to reduce the pressure on the margin and establish realistic margin goals.
In addition to a strategic plan, the ALCO need an ALCO policy to serve as a guide as the ALCO moves forward. Most recently developed ALCO policies include measurement of risk using simulation results and margin minimum and maximums, or possibly allowable margin changes under multiple rate scenarios, high, low and most likely.
Finally, an ALCO action plan should be the product of the meeting. Always conclude your ALCO meetings with specific set of actions to be executed by designated individuals operating within a specific timetable. Even if everything is going according to plan and the committee elects to do nothing, that is an action plan and should be noted in the minutes. With this simple discipline, you will reap substantial rewards for your efforts.
Check back for parts two and three of this series, "Why ALCOs Fail: The Wrong Tools" and"Why ALCOs Fail: Staffing the ALCO".
Why Community Bank ALCOs Fail: An Unclear Purpose
Posted by
Craig Hartman on 6/11/14 3:00 PM
Topics: strategic thinking, interest rate risk, community bank, community bank strategy, community bank ALCO, fintech, ALCO