Banking 101 - Risk Management & Asset Liability Management

Explore the trade-off between profitability and risk in banking, noting how higher profits and risk can drive growth and innovation but threaten stability, capital, and reputation.

This overview explains bank steering to manage credit, market, and liquidity risks through asset-liability and capital management, transfer pricing, and governance, guiding long-term profitability and compliance.

Banks generate income primarily from lending and net interest income, including margins, plus income from fixed income securities, interbank lending, and non-interest fees, trading, and wealth management.

Develop asset liability management to optimize banks' risk-return, liquidity, and capital adequacy by aligning assets and liabilities, assessing gaps, and hedging interest rate risk with derivatives.

Explore how banks use money market instruments (t-bills, CDs, repos) and capital market instruments (bonds, derivatives, ABS, MBS, structured products) to manage asset liability management and optimize liquidity and risk.

Define funds transfer pricing as pricing internal funding costs at arm's length to allocate funds across units, measure profitability, and manage interest rate risk.

Explore a simplified fund transfer pricing example across banking divisions: deposit, treasury, and lending, calculating FTP, funding costs, and net interest margin to allocate internal funds.

Banks use risk management frameworks and tools to identify, assess, monitor, and mitigate credit, market, liquidity, operational, cybersecurity, country, model, and ESG risks, supporting financial stability and regulatory compliance.

Assess credit risk, the potential borrower default and late payments, and discover how banks manage it through scoring, underwriting standards, diversification, collateral, monitoring, covenants, stress testing, and provisions.

Banking 101 introduces predictive analytics in credit risk modeling, using historical and real-time data, algorithms, and machine learning to forecast defaults and optimize underwriting under IFRS 9 and Basel III.

A credit default swap transfers credit risk from the protection buyer to the protection seller via premiums, a reference obligation, and a reference entity, with settlement on a credit event.

Learn how securitization turns illiquid assets like mortgages, car loans, and credit card receivables into tradable securities, transferring risk, boosting liquidity, and enabling diversified, tranche-based investing.

Explore securitization, detailing asset selection, SPV transfer, security issuance, and tranche-based cash flows managed by servicing. Show the 2008 crisis role of subprime securitization, rating agencies, and leverage.

banks manage interest rate risk through asset-liability management, aligning maturities and repricing, using risk models, stress tests, and hedges like swaps, FRAs, caps, floors, and futures.

Learn how interest rate swaps convert a variable loan to fixed by exchanging fixed and floating payments on a notional amount, using sofr as the reference rate.

Credit spread risk affects banks' profitability, asset valuations, liquidity, and funding costs. Banks mitigate it through diversification, hedging, stress testing, and regulatory-compliant risk management.

Bank currency risk arises from cross-border activities and FX trading, affecting assets, liabilities, and loans; the lecture covers hedging, diversification, netting, and stress testing to manage exposure.

Examine liquidity management principles and regulatory requirements to ensure resilience, and apply asset liability management to align cash flows with maturities, risk appetite, and funding diversification.

Banks address liquidity risk by liquidating government securities, renegotiating liabilities, borrowing in interbank and money markets, using repos and central bank facilities, and engaging in risk mitigation and stakeholder communication.

Explore repos as short-term financing through sale and repurchase of securities, secured by collateral like government bonds and treasury bills, with a repo rate reflecting borrowing costs.

Explore how capital adequacy supports risk bearing capacity by using buffers and Basel Accords to absorb losses from credit, market, and operational risks.

Explore Basel III, the international framework with three pillars: pillar one minimum capital for credit, market, and operational risk; pillar two supervisor review; pillar three market discipline through disclosure.

Banking regulation mitigates systemic risk, ensures financial solvency by setting capital adequacy, guides prudent risk management and stress testing, and promotes transparency and public trust for financial stability.

Analyze asset-liability mismatches that fueled the global financial crisis, with long-term illiquid assets funded by short-term liabilities. Show how MBEs, MBS, CDOs, via SIVs and ABCP, amplified liquidity risk.

Differentiate the banking book and trading book to apply risk management and regulatory approaches; banking book is held to maturity with cost accounting, while trading book is marked to market.

Trace asset-liability mismatches that fueled fire sales, margin calls, and mark-to-market losses during the GFC, then explore reforms like fair value hierarchy and Basel III liquidity rules.

Shows how liquidity dried up during GFC due to asset liability mismatches in banks and shadow banks, and how central banks and governments restored stability with facilities, guarantees, and recapitalization.

Explore how asset liability mismatches and duration risk in long-dated securities fueled the March 2023 crisis, as uninsured deposits triggered rapid bank runs and policy responses to restore liquidity.

Explore how maturity transformation and liquidity transformation interrelate, linking short-term deposits and wholesale funding to long-term mortgages and business loans while highlighting run risk, confidence, and systemic fragility.