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ALM lessons to calm us in crisis times
November, 29th 2007

Can ALM (asset-liability management) be piloted automatically? Will large non-financial corporates develop their own ALM teams? Does the ALM segment face a human resource shortage?

Alexandre Adam leaves these questions open in Handbook of asset and liability management ( ). But the 500-plus-page book explains all the written and unwritten rules of ALM in detail, making it easier for everybody to understand the business.

ALM is current. It figured in the speech of the central bank chief on November 27, at the Bankers Conference 2007, in Mumbai. The RBI (Reserve Bank of India) had issued broad guidelines for asset-liability management and banks have flexibility in devising their own risk management strategies as per Board approved policy, said Dr Y. V. Reddy. He then went on to list the steps taken by the RBI to mitigate risks at the systemic level and at the institution level as regards liquidity risks at the very short-end.

ALM is something that evolved out of banking and insurance history, observes Adam. The financial crisis of the 1980s and 1990s (from S&Ls to LTCM) proved the importance of risk management in decision-making. During this period, frightened executive managers created or empowered risk management departments. ALM teams were formed at the same time, bringing organisation and strategy into question.

Bankers life earlier was perhaps a cushy one. From 1929 till the mid-60s, the interest rates did not move a lot, the author narrates. Bankers used to play according to the 3-6-3 rule: taking deposits at a 3 per cent rate, lend at 6 per cent rate, and go to play golf at 3 o clock.

The S&L (savings and loans) crisis of the early 1980s, in the US, saw the net S&L income go down from $781 million to negative $4.6 billion, all because of an asset/liability mismatch with a steep ascent of interest rates. S&Ls with $43 billion in assets failed, and nearly 500 voluntary mergers happened; also, there were more than 250 supervised mergers.

The first lesson of the S&L crisis was a regulatory lesson: a need for a qualified, strong, and effective supervision independent from industry with adequate financial resources, recounts Adam. The second lesson of this crisis was the need for indicators to monitor the mismatch risk between assets and liabilities: ALM was born.

As if to shock us from the smugness of any learnt-lessons, there are the scary parallels between then and now, cautions Mike Larson in . In the marbled halls of US leading banks ... and the wood-panelled boardrooms of top investment firms, theyre facing the biggest credit meltdown since the S&L crisis of the late 1980s and early 1990s, he says in an article titled The new savings and loan crisis dated November 27.

Yet, before Larsons message can rob you of your appetite, here is a pre-emptive reassurance from the RBI: that the sub-prime crisis is not happening closer home. Our banks with overseas presence have confirmed that they have insignificant exposure to the US sub-prime mortgage market, said Dr Reddy, in his Bancon speech a few days ago. Wonder if the opposite is also true.

Adams book of ALM lessons can possibly calm us in these crisis times, and also help us in decoding any unfolding mismatches.

* * *

Demonstrate and document superior value

You believe that your products or services deliver superior value to customers, but you have difficulty in persuading customers of this. Help is at hand in Value Merchants by James C. Anderson, Nirmalya Kumar, and James A. Narus ( ).

CVM or customer value management is their prescription, to guide you into a philosophy of doing business based on demonstrated and documented superior value. They define CVM as a progressive and practical approach to business markets that, in its essence, has two basic goals: one, deliver superior value to targeted market segments and customer firms; and two, get an equitable return on the value delivered.

Dont take the purchasing managers for granted, they are getting sophisticated in their strategies and tactics, the authors remind. Working at the customers end, and held increasingly accountable for reducing costs, these managers dont have the luxury of simply believing suppliers claim of cost savings. On the other side, the vendors managers find themselves driven in a race to match competitors prices.

No, you can combat price concessions and commoditisation pressures, the book assures. One technique, as followed in Nijdra Groep in the Netherlands and Rockwell Automation, is value case history, a written account that documents the cost savings or added value that reference customers have received.

Another tool, as in SKF, is value calculator a spreadsheet application that salespeople can run on their laptops as part of a consultative selling approach to demonstrate the value.

Document the cost savings and incremental profits that the offerings have delivered to customers, the authors urge.

Of interest should be this simple example that demonstrates the power of value proposition. For a moment, put yourself in the role of a commercial grower, it begins. Two suppliers are offering you mulch film, which is a thin plastic sheet that commercial growers place on the ground to hold in moisture, prevent weed growth, and allow vegetables and melons to be planted closer together.

The first supplier says, Trust us. Our mulch film will lower your cost. The second one says how his film lowered the cost by $16.83 per acre Obviously, the latters value proposition is more persuasive.

Use value word equations to steer clear of fishing tales and spreadsheet mania and present in clear and easily understandable language how customers can lower their costs and/or increase their revenues.

For instance, a unique service such as a chemical supplier collecting used drums from the customers site must be translated into the customers cost savings from not having to dispose of used containers in an environmentally safe way.

An instructive case is of Milliken, which used a joint team (with members from customer organisation) to develop detailed and transparent metrics for assessing the value created by its solution. In five years, the solution reduced the customers inventory by 66 per cent and achieved five years of 100 per cent on-time delivery. The customers market share increased by 10 per cent, and its total cost of ownership was reduced by more than 15 per cent.

Equally enlightening is the Tata Steel case discussed in the book. The CVM exercise in the Tata Steel is not adversarial but mutually reinforcing, the authors find. The customer also begins to contribute ideas on potential value drains and leaks.

The magical moment happened like this, in the tubes business. Tata supplied steel tubes to a boiler manufacturer located a thousand miles away. The tubes, after manufacturing, were specially oiled to avoid rusting en route to the customers plant. Bizarre as it may seem, the customer first cleaned the oiled surfaces and then treated them to pick up rust in its plant!

CVM assessment revealed something interesting: that a little bit of rust on the tubes was desirable to create enough friction between the tube and the bobbin drum while making coil-type boilers.

The authors narrate how a win-win situation emerged for both firms when the oiling process and the subsequent cleaning process were eliminated. This has resulted in $30 to $40 of savings per metric tonne for the customer.

Value read.

Giveaway signs of earnings manufacture

Managing earnings is a tricky business, write Scott C. Newquist and Max B. Russell in Corporate Governance: A Financial Perspective ( It may start out as a well-intentioned effort to reduce price volatility and, in a certain sense, to protect shareholders interest. Unchecked, those good intentions can become the proverbial paving stones to a far more sinister place.

When a company walks the road from earnings management to earnings manufacture, you can see the signs, the authors say. For example, smoothing earnings can be a giveaway. Execs dont actually exaggerate total earnings growth, but by lowering the likelihood of earnings surprises, they can mitigate quarterly stock price volatility and bolster investor confidence in the companys future prospects.

Therefore, if the earnings are never off by more than a few pennies from the consensus figure, or if they are promising continual growth in the face of a deteriorating environment, take note, the authors caution.

Important reference.


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