What is asset-liability management and why do banks need a dedicated ALM function?

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Asset-liability management coordinates the structure of a bank's balance sheet so that interest rate, liquidity, and currency mismatches between assets and liabilities do not threaten earnings or solvency. Unlike trading-book risk, which measures daily mark-to-market volatility, ALM risk lives in the banking book: loans, deposits, bonds held to collect contractual cash flows. The ALCO (Asset-Liability Committee) meets monthly or quarterly to review three core metrics: net interest income sensitivity to rate shocks, economic value of equity, and liquidity coverage. Typical ALM actions include adjusting the mix of fixed versus floating loans, issuing term funding to extend liability duration, hedging with interest rate swaps, and setting deposit pricing to manage behavioral runoff. ALM is distinct from treasury funding management in scope — treasury executes, ALM sets policy and limits. The function exists because banks are fundamentally in the business of maturity transformation: borrowing short (deposits) to lend long (mortgages). That mismatch produces net interest margin but also exposes the bank to a flattening yield curve, sudden deposit outflows, and convexity mismatches from prepayments and early-withdrawal options. Regulators now require Pillar 2 capital for interest rate risk in the banking book (IRRBB) and impose standardized rate shocks to measure EVE changes, so ALM has moved from discretionary best practice to a board-level regulatory requirement.

What is asset-liability management and why do banks need a dedicated ALM function?

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