Understanding the importance of ALM in banking
Net Interest Income (NII) is a core driver of bank profitability. For balance sheet managers, optimising NII is not only about improving margins—it’s about strengthening structural resilience and ensuring earnings stability under stress.
This article explores how banks can enhance NII through refined ALM strategies, with an emphasis on behavioural modelling, scenario-based planning, and cross-functional alignment.
Learn more about MORS’ Asset and Liability Management solution and how it supports balance sheet managers in navigating these challenges.
1. Balance Sheet Behaviour Modelling: The Foundation of NII Forecasting
Understanding how assets and liabilities behave under different rate conditions is essential to any NII strategy. Balance sheet managers should regularly assess:
-
Non-maturing deposit (NMD) stability and sensitivity to rate changes
-
Loan portfolio prepayment behaviour and its impact on effective duration
-
Pass-through assumptions for both assets and liabilities
Improving the accuracy of these models enhances both the precision and credibility of NII forecasts.
2. Advanced Scenario Analysis: Beyond Parallel Shocks
Effective NII steering depends on robust forward-looking analysis. Banks should expand their scenario set to include:
-
Non-parallel yield curve shifts (e.g. steepening, flattening)
- Gradual yield curve shifts
-
Basis risk and reference rate transitions
-
Behavioural changes in customer response under rate volatility
- Product migration
Running these scenarios enables balance sheet managers to evaluate earnings resilience under multiple market conditions—not just regulatory templates.
3. Profitability Steering Through Internal Pricing and Portfolio Allocation
While Treasury often manages execution of funding and hedging, the strategic levers to influence NII rest with balance sheet management:
-
Funds Transfer Pricing (FTP) should reflect true marginal cost of funds, enabling better pricing and portfolio steering
-
Product and segment profitability analysis supports more informed decisions on where to grow or reduce exposure
-
Balance sheet mix optimisation should align with strategic objectives and risk appetite
These decisions require close alignment with Finance and Business Units, even if Treasury supports them operationally.
4. Structural Hedging: A Tool, Not a Crutch
Hedging strategies can help stabilise NII, particularly where structural mismatches exist. However, derivatives should be used with clear objectives and not as a substitute for balance sheet optimisation. Common tools include:
-
Interest rate swaps to hedge cash flow volatility
-
Macro hedging approaches to stabilise banking book earnings
That said, hedging decisions should always follow from risk analytics—not precede them.
5. Systems That Support Dynamic NII Forecasting and Stress Testing
To move beyond static analysis, ALM systems must offer:
-
Multi-horizon NII simulation capabilities
-
Integration with behavioural models and interest rate forecasts
-
Alignment with ICAAP, IRRBB, and internal planning frameworks
System agility is key—tools must support iterative planning, not just annual exercises.
6. Institutionalising NII as a Strategic Steering Metric
Finally, NII optimisation should not be confined to the ALM function. Embedding NII insight into pricing strategy, business planning, and risk appetite frameworks creates a more coordinated institutional response to market shifts.
When NII becomes a shared concern—anchored by data but led by balance sheet management—it supports better decisions across the bank.
Conclusion
Enhancing NII is not about short-term fixes—it requires a disciplined, model-driven approach to balance sheet management. By investing in behavioural insight, advanced scenario modelling, and integrated planning, banks can achieve stronger, more stable margin performance across rate cycles.
We, at MORS Software, offer innovative solutions that empower banks to streamline their ALM processes. By leveraging cutting-edge technology, banks can improve their risk management capabilities, enhance financial optimisation, and ultimately boost net interest income. As the banking landscape continues to evolve, technological integration in ALM remains a key driver of success and profitability.