It's a new year and amid all of the uncertainty that will shape economic and business conditions for 2014, including the timing and magnitude of a potential rise in interest rates, credit unions can still attain peak performance. To do so, they need to resolve to get back to basics and re-evaluate or at least validate their business strategy. Credit unions need to be able to evaluate their options, perhaps quite frequently. They also need to constantly monitor and analyze their performance if they expect to successfully execute their business plan.
The credit unions that will be successful in the face of uncertain conditions are those that plan for their impact, to the extent that they can, monitor the results of their plans, and act based on an analysis of their ongoing performance. Asset-liability management can help, by providing credit unions with a real understanding of what is taking place on their balance sheets. ALM also helps to ensure that credit unions are proactively managing their balance sheets in the context of their business strategy.
Asset-liability management involves the management of risk that derives from changing interest-rate levels and the impact they can have on earnings stream and value such as market risk, inclusive of interest rate risk. ALM also involves managing the risk that insufficient cash will be generated from either assets or liabilities to meet membership needs or to exploit unanticipated business opportunities or liquidity risk. In addition, ALM can involve managing the risk and impact of loans and investments not being repaid such as credit risk.
Credit unions should consider that their business strategy and its execution significantly influence the potential impact of these risks. For this reason, ALM needs to be considered in a broader context. That context is a discipline known as enterprise performance management. EPM frames the condition, risks and prospects of a credit union by linking the elements needed to plan, monitor and manage the execution of business strategy. On a micro level, EPM, and the orchestration of strategy, take the form of tactical activities such as setting goals and targets, forecasting and modeling, planning and budgeting, and monitoring, analyzing and reporting results. It's here that ALM informs and supports EPM.
Credit unions can also use ALM to help measure and assess the financial viability of various business strategies and plans, along with related risks and their impact. It can add insight to decisions around pricing, product mix, size, growth and structure of the balance sheet.
When implemented, ALM can help pinpoint the source, timing, magnitude, direction and impact of interest-rate risk on earnings and value, providing the opportunity for credit union management to build, test and execute business strategies to mitigate these risks. In addition, net-interest income is the most significant contributor to earnings; managing it via ALM is crucial in the formulation and execution of credit union business strategy. EPM links risk management and financial management. This link is essential for decision making and optimal institutional performance.
Consider the opposite of this important linkage, which is a credit union flying blind in uncertain economic and business conditions. The most extreme outcome could be institution failure. Along the road to that failure, a credit union may encounter missed opportunities, surprises, declining net interest margins, and insufficient liquidity, not to mention increasing levels of regulatory pressure and oversight.
Credit unions need to plan, monitor and act, and ALM should be employed as an integral part of strategy formulation and business planning. ALM is too valuable to be considered only a regulatory or compliance exercise and it is too valuable to be conducted in a silo. Beyond the measurement of financial risk, ALM is a key process that can impact overall financial performance.
In the environment we face, credit unions can either hunker down or take the opportunity to grow. The latter approach will require a precise business plan to get it right. ALM, in the context of EPM, is the key source of information to support the decisions needed to ensure success.
Don Shaurette is director of market intelligence for financial and risk management solutions at Fiserv. He can be reached at 678-475-5389 or [email protected].
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