In the complex world of Asset and Liability Management (ALM), certain concepts can seem as puzzling as organizing a lifetime's worth of clothing. Today, I am going to simplify three key elements of ALM using an analogy everyone can relate to: managing your own wardrobe.
The purpose of this post is to give you a simple and clear understanding of these key elements; namely the Business Evolution Plans, Allocation Schemes and Synthetic Instruments, even if you have never set foot in a bank's strategy department.
Your Wardrobe of the Future (The Business Evolution Plan)
Imagine your entire wardrobe as a bank's portfolio of financial products. A Business Evolution Plan (BEP) is like planning how your wardrobe will evolve over the coming seasons. It's not just about what you have now, but what you'll need in the future.
- Growth projections: Just as you might plan to add more business casual attire for a career change, a bank might project growth in certain product areas. For instance, if the housing market is booming, they might plan to offer more mortgage loans. This is like you anticipating needing more suits for a new office job.
- Reduction plans: Similar to deciding to dial down your collection of formal wear because you attend fewer galas, a bank might plan to decrease its offerings in certain product lines or markets. Perhaps they're reducing their focus on personal loans in favor of business loans.
- New additions: Like introducing a new style or trend to your wardrobe (think adding sports wear for a more active lifestyle), banks use BEPs to plan the introduction of new financial products. This could be a new type of savings account or an innovative investment product.
- Time horizons: BEPs typically cover multiple future time periods. It's like planning your wardrobe for the next month (you need a new raincoat for spring), the upcoming season (summer vacation means more beachwear), and the following year (you're attending a wedding next winter). Banks similarly plan for short-term, medium-term, and long-term changes in their product offerings.
- Balance and strategy: Just as you'd want a balanced wardrobe for various occasions - work, leisure, formal events - BEPs help banks maintain a strategic balance in their product portfolio. This ensures they're prepared for different economic scenarios, just as your varied wardrobe prepares you for different social situations.
Your Personal Stylist (The Allocation Scheme)
If the BEP is the plan for your future wardrobe, the Allocation Scheme is like having a personal stylist who decides exactly what pieces to buy and in what quantities. This stylist doesn't just say "buy more casual wear," but specifies "add three pairs of khakis, two blue button-shirts, and one pair of brown loafers."
- Detailed distribution: Your stylist (the Allocation Scheme) determines how many of each type of clothing item you should add or remove. In banking, this translates to deciding not just to increase mortgage loans, but specifying how many of each type (fixed-rate, adjustable-rate, 15-year, 30-year, etc.) should be added to the portfolio.
- Prioritization: Like deciding whether to invest more in quality basics or trendy pieces, the Allocation Scheme helps banks prioritize growth in specific areas. Maybe you need more versatile pieces that can transition from day to night, just as a bank might prioritize products that serve multiple customer segments.
- Risk management: A good stylist ensures your wardrobe remains versatile for various occasions and unexpected events. Similarly, the Allocation Scheme helps banks manage risk by ensuring they're not overly reliant on any one product type, just as you wouldn't want a wardrobe full of only formal wear.
Your Custom Tailor (Synthetic Instruments)
Synthetic Instruments are like having a skilled tailor who can create unique, custom clothing by combining elements from existing pieces. This is not just about small alterations; it's about creating entirely new items that serve very specific purposes.
- Custom creation: Banks can create new financial products by combining features of existing ones. Imagine a tailor creating a jacket with the comfort of a sweater, the water-resistance of a rain jacket, and the professional look of a blazer. In banking, this might be a savings account with the high interest of a Certificate of Deposit, the flexibility of a checking account, and the investment options of a money market account.
- Risk management tools: These custom pieces often help banks better manage their risk exposure. It's like creating adaptable clothing for unpredictable weather - perhaps a jacket with removable layers for unexpected temperature changes. In banking, a synthetic instrument might combine aspects of different products to hedge against interest rate fluctuations or credit risks.
- Competitive advantage: Just as custom-made clothing fits perfectly and stands out, Synthetic Instruments allow banks to offer unique products that may not be available elsewhere. This could be a mortgage product that automatically adjusts its terms based on the borrower's changing financial situation, providing a unique selling point in a competitive market.
Putting It All Together:
- The Business Evolution Plan outlines the bank's strategic vision for its future product portfolio. It's like your overall plan for an ideal wardrobe - "In five years, I want a versatile, professional wardrobe with a touch of creative flair."
- The Allocation Scheme provides the detailed roadmap for achieving this vision, specifying exactly what to buy or remove. It's the shopping list from your personal stylist - "Buy these specific items in these quantities to achieve your wardrobe goals."
- The Synthetic Instruments offer flexibility, allowing banks to create custom products that fit precisely into their strategic plan. This is your tailor creating unique pieces to complete your wardrobe - pieces that serve specific needs and can't be found off the shelf.
These tools, working together, allow banks to make informed decisions about their future, manage risks effectively, and stay competitive in an ever-changing financial landscape. It's like having a wardrobe strategy that ensures you're always appropriately dressed, no matter the occasion, season or how fashion trends change.
Conclusion
While these banking concepts may initially seem as daunting as organizing a chaotic closet, they're fundamentally about strategic planning and smart resource allocation - ideas we can all relate to in our daily lives. By viewing these complex financial strategies through the lens of wardrobe management, I hope you can better appreciate the thoughtful planning that goes into maintaining a healthy, balanced, and forward-looking banking system.
For those interested in exploring how these concepts are implemented in SAS ALM on Viya, the official documentation is a good start and provides a wealth of detailed information.
Find more articles from SAS Global Enablement and Learning here.
