Strategic interest rate risk management : a corporate ALM perspective
Van der Walt, Rudolf Johannes
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During the early 1980's there was a sudden and dramatic increase in bank failures in the United States of America. In fact, the situation was so desperate, that it threatened to collapse the entire financial system of that country. Subsequent investigations into the cause of the bank failures showed that the banks had failed because the traditional model of managing the assets and liabilities of a bank separately could not cope with modern demands. The banks that had survived the ordeal all had some form of communication between the managers of assets and the managers of liabilities. This realization led to the birth of the field of Asset and Liability Management, or ALM. Today, ALM is widely used by banks and other entities in the financial services industry as the accepted method of managing financial risk. Strangely, the same cannot be said of the other industries. Traditionally, corporates in the manufacturing, agricultural and retail industries were involved solely in the buying and selling of goods and services, a business model which does not require an ALM process. Over the last few decades, however, the face of the corporate sector has changed dramatically. Many corporates are now involved in activities which are traditionally associated with banks. This is especially true in the agricultural and retail industries. For example, agricultural co-operatives borrow money from banks, which they on-lend to their members. Many retail companies have in-store credit cards, as well as other types of finance, which they offer to their clients. As a matter of fact, there are several retail companies in South Africa who derive the majority of their income from the interest they charge on their debtors' book. Through these activities, corporates are exposed to the same risks as banks, and they should therefore employ risk management methodologies similar to those employed by banks. This dissertation explores the history of ALM and establishes the need for ALM in the corporate sector. It then shows how the ALM methodologies developed for banks, as well as the financial instruments used to hedge interest rate risk, can successfully be applied to strategic interest rate risk management in the corporate sector.