La gestion des risques de taux d'intérêt et de change par l'approche ALM: Le cas de la Banque Ouest Africaine de Développement (BOAD)
par Arouna Soro
CESAG - Master en Banque et Finance 2006
The ALM Approach To The Management Of Interest and Exchange Rate Risks
The Case Of The West African Development Bank (WADB).
Interest of the topic
There are two types of risks: a positive one and a negative one. The positive risk or upside risk can be defined as the risk for a company to meet increasing profits while the negative risk or downside risk is the opposite. The latest is the one that frightens a lot all companies' managers because of its trickle down effects. Then they must manage carefully that kind of risk.
As far as a company is concerned, the risk management should be a priority. If not, the company loses a powerful tool in decision making. The quality of its results, its solvency and consequently the future of the company will also be compromised. This is very important as there is a large range of risks interconnected one to the others. Therefore, a perfect identification or taxonomy of risks and the choice of an accurate method of measuring them are prior to their effective management.
There are many ways for managing risks like immunization, forward hedge and diversification. But since a few years, banks are using Asset and Liability Management (ALM) in order to manage their interest and exchange rate risks and their liquidity risk. The ALM which aims at balancing risk and profitability is based on a three-step approach: its attributions and links with the other departments of the company, the identification and the measure of the risks and finally the management of these risks. The latest should focus on setting up the objectives, the constraints and also the managing action to be undertaken. Meanwhile, the implementation of ALM requires a great implication of the board of directors, an ALM committee or ALCO and a sophisticated information system.
The West African Development Bank (WADB) has set up an ALM system since 2001 and describing its experience should promote this approach. If they use it, commercials banks will benefit from an ALM approach as well as WADB which lends money to these banks. In fact according to some repricing agreements, WADB lends money to primary banks and so expects a Return On Investment (ROI). On the other hand, talking about the WADB's experience in ALM leads us to compare the practice of that subject in that bank to what should be done in theory. We'll then underline the inherent weaknesses and make a contribution for a better risk management.
Problem to solve
We are aiming at a double goal:
- firstly, we'll make a complementary proposal to the WADB in order to measure its interest rate risk. This method is called the value measure. In fact, up till now the WADB is measuring its interest rate risk by assessing the impact of interest rate fluctuation on the net interest rate margin and on the Profit and Loss (P&L). This measure is unable to give a bright analysis of interest rate risk as the risk manager can't forecast what would be the value of assets and debts if the interest rate fluctuates. Neither can he assess the impact on the value of equity. This is the purpose of the value measure.
- secondly, we aim at making a contribution to ALM promotion in the banking field of West African Economic and Monetary Union (WAEMU) just because its practice is still not enough well known in our countries. This is why the case of the WADB could be profitable for the banks of WAEMU zone.
In order to reach the above goals, we'll first of all set up the theorical framework of the ALM approach to interest rate and exchange rate risk management. Secondly, we'll describe the implementation of ALM at the WADB. Comparing both of them, we'll be able to draw the strengths and weaknesses of the ALM implementation at the WADB. Thus, the theorical analysis will the be guideline that helps us to make our proposal of the interest rate risk value measure since the WABD already uses the net interest margin measure of interest rate risk.
Difficulties we faced
We were facing one major constraint in our survey. This constraint is relative to information disclosure. We were therefore led to use data of 2004 instead those of 2005 as we would prefer. That is the case of our balance sheet which is not only a very simple one but also a balance sheet drawn with accounting data instead of trading book data. The matter is that the value measure of interest rate risk made on a trading book data is more convenient as it reflects the market reality.
Diagnosis of the situation
The WADB has implemented its ALM system since 2001 in its Risks Management Unit (RMU) which became the Risks Management Division (RMD) in January 2005. This system was
computerized by Crédit Agricole Consultants a French consulting company. It is focusing essentially on interest rate risk and exchange rate risk management even if it is also in charge of liquidity risk management. An ALM Committee has also been set up. It meets on a quarterly basis and makes
proposals to the President of WADB after a relevant analysis of interest rate and exchange rate risk. It's up to the President to take the right decisions and to charge the operational departments to execute them.
However ALM is not an easy subject. It is recent among the banking managing fields and indeed it is for WADB. That's why some strengths and weaknesses can be underlined.
The strengths are relative mainly to:
- the ALM Committee which meets quarterly
- the fact that many employees are trained to ALM
- the implementation of a tool in order to make simulations for interest rate and exchange rate risk management
- the fact of setting hurdle rates for risks hedging
Despite of these strengths, some weaknesses are still bordering the ALM efficiency at WADB:
- the members of the ALCO team move very often. This can lead to a misunderstanding of the last proposals and their bad implementation
- there are just two (2) employees in the Risks Management Division (RMD). We do think that this number of employees is insufficient
- the information system is not performing well as it cannot provide real time data
- the interest rate risk is just measured by its impact on the net interest margin and the Profit and Loss (P&L)
- the hurdle rates for risks hedging seems to be irrelevant
- There's no notional division of the bank into responsibility centre in order to perform pricing system and the allocation of equity.
Taking into account the above weaknesses, our proposals will be set in eight (8) points:
- increase the number of employees of the Risk Management Division (RMD)
- perform the information system in order to provide real time data
- perform the simulation tool in order to provide more features for a better exchange rate risk management
- fasten the implementation of the managerial accounting and control
- implement the value measure of interest rate risk
- re-think the idea of letting the borrowers support the exchange rate risk because they are not as well equipped as the WADB to manage properly that risk. Moreover this strategy can lead to a counterparty risk for the Bank
- make a new assessment of the hurdle rates for risks hedging as they were computed in the 80's
These proposals should be taken into account for a better interest and exchange rates risks management. We would like to focus particularly on the value measure of interest rate risk adoption in order to make it part of the risks measuring tools of WADB.
Our own estimations give a proof that if that measure is well conducted it remains consistent with the other ways of measuring interest rate risk. In addition it gives a better sight of interest rate risk which measures its impact not only on the net interest rate margin but also on the value of assets, debts and equity. Therefore the value measure helps the risk manager to make a better analysis and management of this risk. Moreover the risk manager can take better commercial and strategic decisions.
- firstly, a team should be set up in order to make a better analysis of the implementation of the value measure because of the limits and constraints that we faced in doing our own analysis. This team should be given all necessary human, financial and material means to succeed in his task. The team will also have to make some proposals to the President of the WADB.
- secondly, all the technical and material tools required for a good implementation of that solution must be set up. In addition, conversant employees must be trained or recruited for interest rate risk management including the value measure.
- thirdly, this measure must be adopted and its results controlled periodically.