Strong capital will not guarantee liquidity in all circumstances. There can be panics and sudden increase in the demand for liquidity. It is the job of the central banks to help in those circumstances. But a strong capital base in the system and in all its components is likely to limit future liquidity shocks.
Liquidity management is a provoking idea for the man agement of the financial insituations to ponder about and act. But how to act and when to act are the questions which lead to Asset and Liability Management (ALM), a management tool to monitor and manage various aspects of risks associated with the balance sheet management, including the management and balance sheet exposure of the institution. To put it otherwise, "ALM is an ongoing process of formulating, monitoring, revising and framing strategies related to assets and liabilities in an attempt to achieve the financial objective of maximizing interest spread or margins for a given set of risk level." It is, thus, not only a liquidity management tool, but also a portfolio management tool to alter the composition of asset and liability portfolio to manage the risk by using various risk mitigating measures.
The RBI, through its credit policy announcements, various directives and guidelines on ALM, has spelt out the need for having a comprehensive risk management policy. The RBI, in its monetary and credit policy and subsequent guidelines issued in February 1999, recommended that an adequate system of ALM be put in place. Further, it even suggested that financial institutions should introduce ALM, which would primarily focus on liquidity management and interest rate risk management. Having, thus, laid these requirements to implement ALM, in the stated order: (a) Developing a better understanding of ALM concepts, (b) Introducing an ALM information system, and (c) Setting up ALM decision-making processes (ALM committee/ALCO), it is for the institutions to act and implement the same.
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