Bank Asset – Liability Management Approach in times of Extreme Uncertainty: A Guide for ALCO Chairs
- Bharadwaj Vishnubhotla & Moorad Choudhry
- Oct 21
- 3 min read
Updated: Oct 25
WHITEPAPER
Today banks are operating under heightened uncertainty. Since early 2025, global markets have experienced considerable volatility, driven by unpredictable policy directions and rapidly shifting economic indicators. This has been reflected in pronounced movements across equity markets and widening spreads in both short and long-term interest rates.
One notable development has been the sharp increase in 10-year US Treasury yields following major policy announcements. Such volatility underscores the market’s sensitivity to perceived shifts in economic strategy and the underlying challenge of anticipating future interest rate paths with any confidence.
Beyond immediate market fluctuations, broader questions are being raised regarding the long-term credibility of core financial conventions specifically, the US dollar’s role as the global reserve currency and the continued treatment of US Treasury securities as “risk-free” assets. While these fundamentals remain intact, they are increasingly being scrutinised in the light of recent market behavior and communication from key institutions.
Of particular relevance to balance sheet and risk managers is the issue of central bank independence. Market confidence has historically been anchored in the belief that monetary policy is data- driven and shielded from short-term political considerations. Any perceived deviation from this principle introduces a structural layer of risk to financial markets. As trust in policy-making frameworks weakens, so too does the predictability require for effective risk management.
For bank Asset-Liability Management (ALM) teams, this presents a significant challenge. The combination of sustained interest rate volatility and the growing likelihood of “stagflation”, where inflation persists even as economic activity slows, requires a recalibration of existing ALM frameworks. Central banks are now attempting to contain inflation while managing the downside risks of contracting trade and global demand.
As such, ALM strategies must remain agile. Balance sheet managers need to prepare for a wider range of scenarios, including potential stress in funding markets, fluctuating liquidity conditions, and more volatile capital market assumptions. In this environment, a robust and dynamic ALM approach is not just prudent, it is essential for resilience and long-term balance sheet stability.
Guidance for the ALM Committee
In the context of heightened market volatility and macroeconomic uncertainty, a key question arises: how should a bank’s Asset and Liability Committee (ALCO) respond to these evolving conditions to ensure prudent balance sheet management?
The core mandate of the ALCO remains unchanged, that is to safeguard the long-term resilience of the balance sheet across the economic cycle, with particular attention to liquidity risk and interest rate risk. However, in light of current market dynamics, the question ALCOs should be asking is: “How should elevated uncertainty shape our near- to medium-term ALM strategy?”
Earlier this summer the US Treasury yield curve reflected a relatively conventional shape. As illustrated in Exhibit 1 (as of 2 May 2025), the curve does not currently signal an imminent recession when viewed through the lens of traditional yield curve analytics. Likewise, the forward rate curve maintained a standard upward slope (Exhibit 2), reinforcing the baseline market expectation of stable to gradually rising rates.
Despite these signals, the apparent normalcy of the yield curve should not lull decision makers into complacency. In an environment where policy signals may be subject to abrupt shifts and inflationary pressures remain persistent, even a conventional curve may mask underlying risks. ALCOs should therefore adopt a forward-looking, scenario-based approach to risk management, ensuring that balance sheet strategies are not overly reliant on static interpretations of market data.
Strategic Considerations for ALCO Amid Structural Uncertainty
While current yield curve shapes may suggest economic normalcy, this conclusion could be misleading. The broader context, marked by uncertainty in future policy direction and concerns about the long-term stability of the US dollar as the anchor of global financial credibility, warrants a more cautious and measured approach to balance sheet management.
In this environment, Asset and Liability Committees (ALCOs) should adopt a defensive, short-to-medium term posture. Below are key principles that we suggest should influence current ALM decision-making:
1. Interest Rate Strategy: Stay Short Where Possible
The predictability of future interest rate movements is significantly impaired. The apparent steepness or flatness of the yield curve cannot be relied upon for directional certainty.
ALCOs should therefore favour shorter asset duration to maintain balance sheet flexibility and minimise duration risk.
2. Long-Term Lending and Interest Rate Hedging
While customer demand will continue to drive long-dated lending, particularly at fixed rates, it is essential to hedge fixed-rate exposures to achieve a floating– floating profile, on a net basis, on the balance sheet.
In scenarios where derivatives markets (e.g., IRS, futures) lack sufficient depth, ALCOs should:
3. Behavioral Assumptions on Non-Maturing Deposits (NMDs)
Conservative assumptions should be applied to the duration characteristics of NMDs and callable deposits. (By “conservative” we suggest that any NMD balance modelled as beyond 3-year in behavioural tenor is being insufficiently rigorous on the assumptions it is applying).
Thus, assuming average tenors beyond 3 years may overstate stability and expose the balance sheet to risk under stress scenarios.
4. Strengthening the Funding Base
Prolonged market volatility is likely to impact funding availability, especially in wholesale markets.
Where possible, prioritise contractual long-term funding and reassess assumptions on the stickiness of customer deposits.
5. Foreign Currency Lending and Funding Stability
Lending funded via short-term wholesale FX lines should be reevaluated for its structural resilience.
Where there is a risk of future disruption in FX liquidity, scaling back lending in affected currencies is prudent.
6. Optimising Liquidity Placement
In jurisdictions where central banks offer yield on surplus balances, consider deploying excess liquidity into central bank facilities as a capital- preserving option during uncertain periods. This follows our earlier mantra of being shorter, rather than longer, duration on the balance sheet
This strategy mirrors a broader institutional trend of holding high cash reserves as a signal of risk aversion and optionality.
7. Currency Diversification Strategy
For banks with multi-currency balance sheets, diversification into euro- denominated sovereign assets, particularly AAA-rated paper, should be explored.
While euro bond markets do not yet fully reflect the depth of USD markets, the potential for further USD weakening supports positioning a portion of the balance sheet in EUR assets, where customer demand allows.
Looking Ahead: A Paradigm Shift in Global Markets?
Cumulative indicators point to the potential for a structural transformation in the global financial system, one not seen since the post-Bretton Woods realignment in the early 1970s. In such a context, adopting a conservative ALM stance is not only prudent but strategically necessary.
For ALCO chairs and balance sheet risk owners, the emphasis should now be on flexibility, resilience, and preserving optionality across funding, duration, and currency exposures. Maintaining this discipline will be critical to operating in an environment in which long- standing assumptions may no longer hold.
From Strategy to Execution - Powered by Surya
To put these to actions, ALCOs need more than high-level strategy - they need tools that enable timely, data-driven execution. Surya’s ALM system is purpose-built to support the tactical implementation of such key balance sheet strategies:
Shorter Duration Positioning: Duration gap monitoring and scenario analysis help ALCOs stay flexible amid volatile rate outlooks.
Fixed-Rate Lending Hedging: Integrated hedge effectiveness tools and tenor bucket limits support risk mitigation when swaps/futures are limited.
Conservative NMD Assumptions: Customizable behavioral models and stress testing ensure deposit tenor estimates are realistic and risk sensitive.
Stable Funding Base: Funding ladder views, LCR/NSFR compliance, and deposit stickiness analytics strengthen long-term funding resilience.
FX Lending Risk Controls: Multi-currency exposure dashboards and stress testing help reduce dependency on unstable foreign funding markets.
Liquidity Optimisation: Identifies surplus liquidity for placement with central banks, optimizing both security and yield.
Currency Diversification: Models currency specific balance sheet scenarios and supports diversification into high-quality assets where appropriate.
In essence, Surya’s ALM solution equips ALCOs with the reliable framework needed to confidently carry out complex strategic decisions. It brings together scenario analysis, daily basis monitoring, hedge effectiveness, behavioural modelling, and regulatory alignment in a single integrated platform, empowering banks to build more resilient and adaptive balance sheets in the face of ongoing market transformation.
Bharadwaj Vishnubhotla
Solution Architect, Surya Fintech
Bharadwaj specializes in liquidity risk, ALM, IFRS 9, and balance sheet management. An NIBM Pune alumnus, he brings experience across implementation, product development, and client engagement.
Prof. Moorad Choudhry
Board Advisor , Surya Fintech
is a renowned banking and finance professional with extensive experience across treasury, ALM, and risk management. He has held senior roles at major institutions and building societies. An accomplished author and educator, he has written several authoritative books on banking and financial markets and continues to mentor the next generation of finance professionals.
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