Best Practices for a Better ALCO


One of the most important operating committees of a depository institution is the Asset and Liability Management Committee (ALCO), which is responsible for the oversight of balance sheet risk management. Understanding the structure of your committee, data gathering processes, balance sheet risks, and systems for managing those risks will improve the decision-making process. A proper functioning ALCO will result in more profitable decisions. Overall, that should be the goal of ALCO: To assess risk and risk appetiteto make profitable decisions.

Understanding Structural Options
ALCOs generally operate under two types of structures: Strategic or Operational. Each has unique differences; however, there are several best practices that both structures can use to achieve their goals. Understanding the differences between a strategic and operational ALCO will help create an ALCO process that achieves the institution’s risk management objectives. 

First and foremost, it must be understood that both structures are acceptable for a depository institution. In fact, some institutions have both or choose to combine both strategic and operational goals into one ALCO. A strategic ALCO is usually comprised of key managers from finance, lending, marketing, operations, and the Board. The emphasis of a strategic ALCO is forward looking. This committee is focused on strategic development and decision making which impacts the long-term goals of the institution. The strategic ALCO is less focused on the day-to-day functions and more directional in nature. For example, a strategic ALCO will be focused on what business lines should be the core of the institution and may ask questions like: How can capital be best deployed? What additional resources are needed to achieve our desired goals?

An operational ALCO is comprised of management staff and is responsible for the oversight of balance sheet risk management. This will include interest rate risk, liquidity risk, capital risk, budgeting, policy and regulatory compliance. The focus is less on making long-term, strategic decisions and more on effectively managing day-to-day functions. Most often, the type of ALCO structure is driven by the size and complexity of the organization. The depth of the management team and the strength of the Board will also be relevant factors.

Participation & Preparation
No matter the structure, an effective ALCO must have a strong Chairperson and contributing members. Members should come prepared as meeting materials are provided well in advance.The meeting’s time and duration should be set to reduce normal routine distractions. The agenda should be concise, and discussion should be focused on pertinent issues. The committee should be actively making decisions, not just using the meeting to disseminate information. The committee should be results oriented with any assigned tasks documented in the minutes and distributed shortly after the meeting.

The Feedback Loop
A well-functioning ALCO will use a strategy feedback loop for better decision making.The goal is to make informed and profitable, risk-adjusted decisions. Members will need information from ALM models and tools to help them assess and measure the risks inherent in the balance sheet. Strategies can then be developed and implemented to mitigate any unacceptable levels of risk. Decision makers must be confident in the model’s assessment of those risks. Any lack of confidence may lead to indecisiveness and ultimately costly mistakes. A strategy must be monitored to verify it is accomplishing the intended results. If not, the strategy must be altered to realign with the desired goals. Remember, a balance sheet and its assessed risks are at a single point in time. Reassessing risk is ongoing as the balance sheet and the environment we operate in changes constantly.

Managing, Not Avoiding, Risks
Assessing and mitigating risk is the main function of ALCO, not the complete elimination of risks. Totally avoiding risk does not guarantee survival and most likely will not lead to profitability or effectively serve your key stake holders. Managing risk through a well-established process of educating the staff, Board members, and regulators is paramount. Withinthis context, ALCO should manage all balance sheet risks including interest rate, liquidity, credit, option, concentration and operational. Each risk carries its own set of risk/reward scenarios. These risks should be managed holistically as one risk could offset or compound another risk. It is essential that ALCO focus on both sides of the balance sheet. Liabilities can be an excellent tool to offset some of the risks on the asset side of the balance sheet.

Having the Right Tools in Place
Critical to all decision making is the proper systems, tools, and reporting mechanisms. Most ALM models cover interest rate risk, option risk, and liquidity as defined by cash flows, but may not address some of the other inherent balance sheet risks. Operational, concentration, and credit risk will require supporting systems to assess their impact more accurately on the balance sheet. Understanding the input data, assumptions used, and limitations to any model will improve the confidence of decision makers. Proper back testing and variance reporting will improve the accuracy of the reports.

Remember, the goal of ALCO is to better understand all the risks inherent in the balance sheet resulting in more profitable decisions. The proper assessment of risk, coupled with the correct risk appetite creates the environment for improved profits. A well-run ALCO is one of the keys to a depository institution’s success.

Thomas Griswold, CFA
Managing Director, Advisory Services
Thomas Griswold joined ALM First Financial Advisors in 2013. As the Managing Director for Advisory Services, Thomas oversees the Advisory Services department, which is responsible for implementing actionable and effective ALM and investment strategies for client financial institutions. In addition, Thomas performs merger and acquisition analyses, and ALM model validations. He also assists with interest rate hedging strategies, and values loan pools to guide trading decisions.

Prior to joining ALM First, he worked as an analyst underwriting commercial credits with PlainsCapital Bank.

Thomas holds a bachelor’s degree in finance from the University of Notre Dame, as well as the Chartered Financial Analyst (CFA) designation. He assists with Junior Achievement Dallas mentoring students on a variety of topics including sound financial planning and career guidance and planning.

John Smith
Director, Advisory Services
John Smith joined ALM First Financial Advisors in July of 2020. In his role as Director, John is supported by our internal team as he develops holistic partnerships with clients to develop successful balance sheet strategies that maximize performance. This includes interpretation of full balance sheet risk analytics and risk positioning to determine the best opportunities for each client to achieve their financial goals.

John provides advice and insights on loan pricing, loan transactions, investment portfolio management, funding strategies, hedging and more. In addition to his leading role working directly with clients, he coordinates internal collaboration to deliver analytics and timely reporting to assist clients throughout the entire process from strategy development through implementation and post-execution analysis.

Prior to joining ALM First, John worked for Detalus Advisors for 18 years.  During his tenure at Detalus, he served in a variety of roles including Managing Director during his ownership period. Most recently, he served as Senior Portfolio Manager after the divestiture of his ownership.  Detalus managed approximately $2 billion of fixed income investments for client banks and insurance companies. Prior to joining Detalus, and after a 2-year stint at a regional broker/dealer, John served as the Chief Investment Officer for First bank of Illinois in Springfield, IL.

John holds a Bachelor of Science in Accounting from Indiana University – Kelly School of Business.  John is a member of the American Institute of Certified Public Accountants.

ALM First Financial Advisors is an SEC registered investment advisor with a fiduciary duty that requires it to act in the best interests of clients and to place the interests of clients before its own; however, registration as an investment advisor does not imply any level of skill or training. ALM First Financial Advisors, LLC (“ALM First Financial Advisors”), an affiliate of ALM First Group, LLC (“ALM First”), is a separate entity and all investment decisions are made independently by the asset managers at ALM First Financial Advisors.  Access to ALM First Financial Advisors is only available to clients pursuant to an Investment Advisory Agreement and acceptance of ALM First Financial Advisors’ Brochure. You are encouraged to read these documents carefully. All investing is subject to risk, including the possible loss of your entire investment.

The content in this article is provided for informational purposes and should not be relied upon as recommendations or financial planning advice. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues. While such information is believed to be reliable, no representation or warranty is made concerning the accuracy of any information presented. Statements herein that reflect projections or expectations of future financial or economic performance are forward-looking statements. Such “forward-looking” statements are based on various assumptions, which assumptions may not prove to be correct. Accordingly, there can be no assurance that such assumptions and statements will accurately predict future events or actual performance. No representation or warranty can be given that the estimates, opinions or assumptions made herein will prove to be accurate. Actual results for any period may or may not approximate such forward-looking statements. No representations or warranties whatsoever are made by ALM First Financial Advisors as to the future profitability of investments recommended by ALM First Financial Advisors.

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