What ALM does · RiskAtoms Academy

By the end you will be able to

1Describe the banking book as ALM sees it: which lines are fixed, floating or administered, and where net interest income comes from.
2Explain what ALCO is: who sits on it, what it decides, and the limits it works within.
3Contrast net interest income and economic value of equity as the two lenses on interest rate risk, and read both off a bank's book.
4Use a limit dashboard to judge a hedging proposal.

Why it matters

Raise every interest rate by one percentage point. Next year RiskAtoms Bank earns £91.7m more. On the same day, the economic value of its balance sheet falls by £98.0m. Did the bank gain or lose? Both, depending on whether you look at income or at value. A bank's loans and deposits run for years, and every rate move shifts both. Someone has to decide how much of that the bank keeps and how much it hedges away. That is asset and liability management, and the committee that does it meets every month.

Core explanation

Running the balance sheet as one position

Asset and liability management (ALM) treats the whole balance sheet as one position. Module 3.5 did that for cash: can the bank pay? This module does it for interest rates: what do rate moves do to the bank's income and value? The positions are in the banking book (L2.2.02: Market risk): loans, deposits and the bank's own bonds and hedges, held to collect interest rather than to trade. The trading desk's rate risk was L3.2.04: Interest rate risk in the trading book. The risk here is interest rate risk in the banking book (IRRBB).

Meet the banking book

Illustrative dataRiskAtoms Bank plc's banking book

The same £67bn balance sheet as Module 3.5, on one made-up reporting date, in pounds, now with how each line reprices: fixed, floating or administered, its customer rate, a SONIA curve with Bank Rate at 4.00%, a macro hedge and a structural hedge. The figures are round illustrative values, not any bank's data. Every lesson in Module 3.6 uses this book, so the figures agree.

Simplifications to keep in mind: customer rates are annual rates; every line sits at one rate; the hedges' rates and history are invented; and there are no foreign-currency positions.

It is the Module 3.5 balance sheet (L3.5.02: How banks fund themselves), line for line, with one question added: when does each rate change? There are three answers.

Fixed: gilts, term deposits, the bank's bonds, and £24.0bn of two- and five-year fixed-rate mortgages. The rate is set until the fix or the term ends.
Floating: central bank reserves, tracker mortgages and corporate loans. The rate follows Bank Rate (4.00%) or SONIA at each reset.
Administered: £40.0bn of current and savings accounts, plus standard variable rate mortgages and cards. The bank chooses when and how far to move them. The share of a market move it passes on is the beta: 10% on personal current accounts, 60% on instant-access savings.

Assets. Interest a year at today's rates, £m.
Line	Amount	Rate	How it reprices	Interest a year
Central bank reserves (earn Bank Rate)	£6.0bn	4.00%	Floats on Bank Rate	£240.0m
Gilts (fixed coupons, not swapped)	£7.0bn	3.30%	Fixed, reprices over 7 years	£231.0m
Covered and AA corporate bonds	£2.0bn	3.90%	Fixed, reprices over 7 years	£78.0m
BBB corporate bonds	£0.6bn	5.00%	Fixed, reprices over 7 years	£30.0m
Listed shares (no interest rate)	£0.4bn	–	No interest	–
Reverse repos with banks, secured on gilts	£3.0bn	3.95%	Fixed, reprices within a year	£118.5m
Unsecured placements with banks	£1.5bn	4.05%	Fixed, reprices within a year	£60.8m
Two-year fixed-rate mortgages	£9.0bn	4.60%	Fixed, reprices over 1.9 years	£414.0m
Five-year fixed-rate mortgages	£15.0bn	3.80%	Fixed, reprices over 4.9 years	£570.0m
Tracker mortgages (Bank Rate + 0.75%)	£3.0bn	4.75%	Floats on Bank Rate	£142.5m
Standard variable rate mortgages	£3.0bn	6.75%	Set by the bank, beta 90%	£202.5m
Floating-rate corporate loans (SONIA + 1.8%, quarterly resets)	£10.0bn	5.80%	Floats on SONIA	£580.0m
Fixed-rate corporate term loans	£2.0bn	5.60%	Fixed, reprices over 7 years	£112.0m
Personal loans (fixed)	£2.5bn	7.00%	Fixed, reprices over 3.5 years	£175.0m
Credit card balances	£1.0bn	12.00%	Set by the bank, beta 25%	£120.0m
Other assets (premises, intangibles, derivatives)	£1.0bn	–	No interest	–
Total assets	£67.0bn			£3,074.3m

Liabilities and equity. Interest a year at today's rates, £m.
Line	Amount	Rate	How it reprices	Interest a year
Personal current accounts	£22.0bn	0.50%	Set by the bank, beta 10%	£110.0m
Instant-access savings	£10.0bn	3.00%	Set by the bank, beta 60%	£300.0m
Retail fixed-term deposits	£6.0bn	4.10%	Fixed, reprices over 3.5 years	£246.0m
Operational corporate deposits	£5.0bn	1.00%	Set by the bank, beta 25%	£50.0m
Corporate call accounts	£3.0bn	3.50%	Set by the bank, beta 80%	£105.0m
Corporate term deposits	£2.5bn	3.50%	Fixed, reprices within a year	£87.5m
Deposits from banks and other financial institutions	£3.0bn	4.05%	Fixed, reprices within a year	£121.5m
Repo funding secured on gilts	£1.5bn	3.95%	Fixed, reprices within a year	£59.3m
Commercial paper and certificates of deposit	£2.0bn	4.20%	Fixed, reprices within a year	£84.0m
Senior unsecured bonds	£4.0bn	5.10%	Fixed, reprices over 7 years	£204.0m
Covered bonds issued	£2.5bn	4.50%	Fixed, reprices over 7 years	£112.5m
Central bank term funding (charged at Bank Rate)	£1.0bn	4.00%	Floats on Bank Rate	£40.0m
Subordinated debt (Tier 2)	£0.5bn	6.50%	Fixed, reprices over 7 years	£32.5m
Shareholders' equity (no rate; excluded from EVE)	£4.0bn	–	No interest	–
Total funding	£67.0bn			£1,552.3m

The book by rate behaviour, £bn
Behaviour	Assets	Liabilities and equity
Fixed	£42.6bn	£22.0bn
Floating	£19.0bn	£1.0bn
Administered	£4.0bn	£40.0bn
No rate	£1.4bn	£4.0bn
Total	£67.0bn	£67.0bn

The shape is typical of a UK retail bank. Most assets are fixed or floating at market rates; most funding is administered and pays far less than Bank Rate. That gap is where the money is made. Over a year at today's rates the bank earns £3,074.25m and pays £1,552.25m, and its swaps add £63.2m: net interest income (NII) of £1,585.2m, a net interest margin of 2.37% on £67.0bn (L1.8.03: A bank’s income statement).

Two hedge books sit on top. A macro hedge of £19.2bn of pay-fixed swaps turns most of the fixed-rate mortgages into floating-rate assets. A structural hedge of £16.0bn of receive-fixed swaps does the opposite for £12bn of current accounts and the £4bn of equity: balances that pay little or no interest whatever Bank Rate does are invested in a rolling five-year ladder, so their income does not swing with Bank Rate. Without the swaps, NII would be £1,522m. L3.6.10: Hedging the banking book covers both in detail.

ALCO: who decides

The board owns the risk. The Basel standard (SRP31.10 and 31.22) has the board, the governing body, approve the strategy, the policies and the risk appetite for IRRBB, and lets it delegate the work to an Asset and Liability Committee (ALCO) that "should meet regularly and include representatives from each major department connected to IRRBB" (SRP31.14). Click the cards to see who sits at the table and why.

Around the ALCO table at RiskAtoms Bank

ExploreALCO's monthly cycle

Click a box to see what happens there.

Data

Finance and treasury pull every position at month end: amounts, rates, repricing dates, hedges, and the behavioural assumptions (prepayment, deposit betas, how long current accounts stay).

ALCO works within limits set by the board (SRP31.23). RiskAtoms Bank has two, both illustrative: in none of the six standard rate shocks may year-1 NII fall by more than 20% of base NII, nor EVE by more than 10% of Tier 1 capital (£3.5bn). The EVE limit sits inside the supervisor's 15% outlier threshold, with room to spare.

Two lenses: income and value

Every rate scenario is read twice. The Basel standard asks for both measures (Principle 4) and sets out the difference (SRP31.28 and 31.29):

	Net interest income (NII)	Economic value of equity (EVE)
Question	How much will we earn?	What is the balance sheet worth?
Horizon	One to three years	Every cash flow to the end of its life
Balance sheet	Constant or dynamic: maturing business is replaced	Run-off: no new business
What moves it	Rates resetting inside the horizon	Discounting of all future flows
Equity	Costs no interest, so what it funds adds to NII	Left out (it has no contractual cash flows)
Who leans on it	Most banks, to manage income	Supervisors, to compare banks and capital

On the book, the six standard shocks give:

Year-1 ΔNII and ΔEVE under the six standard shocks (sterling sizes), £m
Shock	ΔNII, year 1	ΔEVE
Parallel up	+£254.7m	−£257.2m
Parallel down	−£263.3m	+£251.7m
Steepener (short down, long up)	−£191.6m	−£79.6m
Flattener (short up, long down)	+£253.7m	+£10.2m
Short rates up	+£337.5m	−£119.4m
Short rates down	−£307.4m	+£99.8m

The pattern is the lesson. When rates rise, NII rises: deposits reprice slowly and only in part, while floating loans and reserves earn the full move. Yet EVE falls: the bank's long fixed positions, above all the receive-fixed structural hedge, are worth less at higher rates. Part of that hedge is funded by equity, which EVE leaves out, so EVE sees it as an open position. The two measures can point in opposite directions, and ALCO has to manage both.

Sort itIncome lens or value lens?

Which measure answers each question first?

If Bank Rate is cut by 1% next month, how much less will we earn next year?
How much would our fixed-rate mortgage book lose in present value if long rates rose by 2%?
Will a five-year structural hedge smooth our income over the next three years?
Does our worst loss under the standard shocks exceed 15% of Tier 1?

The formal version

Write $A_i$ for the amount of position $i$ , $r_i$ for its annual rate and $s_i = +1$ for assets and receive legs, $-1$ for liabilities and pay legs. Net interest income over a year at today's rates and the margin are

\begin{aligned} \text{NII} &= \sum_i s_i\,A_i\,r_i = \text{£}3{,}074.25\text{m} - \text{£}1{,}552.25\text{m} + \text{£}63.2\text{m} = \text{£}1{,}585.2\text{m} \\ \text{NIM} &= \frac{\text{NII}}{\text{total assets}} = \frac{1{,}585.2}{67{,}000} = 2.37\% \end{aligned}

Economic value of equity discounts each position's cash flows $CF_i(t)$ on the risk-free curve, $D(t)$ being the discount factor (L1.3.03: Present value and discounting). Equity has no contractual flows and is left out. A rate scenario $s$ gives two numbers:

\begin{aligned} \text{EVE} &= \sum_i s_i \sum_t CF_i(t)\,D(t) \\ \Delta\text{EVE}(s) &= \text{EVE on the shocked curve} - \text{EVE on today's curve} \\ \Delta\text{NII}(s) &= \text{NII}_{\text{year 1}}(s) - \text{NII}_{\text{year 1}}(\text{base}) \end{aligned}

For the parallel up shock: $\Delta\text{NII} = \text{£}254.7\text{m}$ and $\Delta\text{EVE} = -\text{£}257.2\text{m}$ . L3.6.04: Net interest income sensitivity builds the NII projection and L3.6.05: Economic value of equity sensitivity the EVE one.

Try it

You have a seat at ALCO. Treasury asks what the two hedges are doing for the bank. Switch each one off and watch the six shocks and the two limits. Then try both off: the answer surprises most people.

Try itSit in ALCO

Shock	ΔNII, year 1	% of base NII	ΔEVE	% of Tier 1
Parallel up	+£254.7m	15.5%	−£257.2m	−7.35%
Parallel down	−£263.3m	−16.0%	+£251.7m	7.19%
Steepener (short down, long up)	−£191.6m	−11.7%	−£79.6m	−2.27%
Flattener (short up, long down)	+£253.7m	15.5%	+£10.2m	0.29%
Short rates up	+£337.5m	20.6%	−£119.4m	−3.41%
Short rates down	−£307.4m	−18.7%	+£99.8m	2.85%

NII limit94% of limit

Worst: Short rates down, −£307.4m against a limit of £328.2m (20% of base NII £1,640.9m).

EVE limit73% of limit

Worst: Parallel up, −£257.2m against a limit of £350m (10% of Tier 1).

Supervisory outlier test (15% of Tier 1, £525m)Passes

Base NII, year 1£1,640.9m

Illustrative book and illustrative limits. Red marks a shock that breaks a limit. NII is the first year's, on a constant balance sheet; EVE leaves equity out. The six shocks are the Basel standard ones at their sterling sizes, built in L3.6.06: The standard shock scenarios.

Worked example

Should the structural hedge be allowed to run off?

A director argues that rates will stay high, so the bank should let its £16.0bn structural hedge mature and keep the deposit money at Bank Rate. ALCO reads the dashboard with and without it. All figures are from the book, in pounds.

From the dashboard to a decision

Step 1 of 4

1
The limits
$\begin{aligned} \text{NII limit} &= 20\% \times \text{£}1{,}640.9\text{m} = \text{£}328.2\text{m} \\ \text{EVE limit} &= 10\% \times \text{£}3{,}500\text{m} = \text{£}350\text{m} \end{aligned}$

Regulatory lens

The Basel IRRBB standard (Basel Framework SRP31, revised in 2016 and recalibrated in 2024) begins with governance: the board approves the strategy, policies and risk appetite and may delegate to an ALCO (Principles 1 to 3); banks measure both economic value and earnings (Principle 4); and they disclose both each year under the six standard shocks (Principle 8; disclosure template IRRBB1 in DIS70). The details, including the standardised framework and the supervisory outlier tests in the UK and the EU, are in M4.5: Liquidity and IRRBB regulation; the behavioural models behind deposit and prepayment assumptions are in M6.7: Liquidity, ALM and behavioural models.

Spark Atoms

Spark AtomAn ALCO, from the inside

Furness Building Society publishes its ALCO's terms of reference (October 2023). The chief executive chairs it; the members include the finance director, the chief risk officer, the group treasurer and the heads of mortgage and savings strategy; it meets at least nine times a year; and its remit runs from IRRBB and behavioural assumptions to product pricing, liquidity and funding. Small or large, the cast is much the same.

Spark AtomBanks watch income, supervisors watch value

The Basel text says it plainly: most commercial banks focus on earnings-based measures, while supervisors tend to favour economic value, because it is comparable across banks and ties to capital (SRP31.29). That is why the outlier test is on EVE, and why banks' own limits usually lead with NII.

Key takeaways

ALM manages the balance sheet as one position: this module covers its interest rate side, interest rate risk in the banking book.
RiskAtoms Bank's £67bn book mixes fixed, floating and administered rates; it earns NII of £1,585.2m, a 2.37% margin, with two hedge books on top.
The board owns the risk appetite; ALCO, chaired from the top and including treasury, risk and the business lines, runs it monthly within board limits, with independent measurement.
NII asks what the bank will earn over one to three years; EVE asks what all its future cash flows are worth today, equity excluded.
The lenses can disagree: in the parallel up shock NII rises by £254.7m while EVE falls by £257.2m.

Reaction

Check what stuck

Glossary

Asset and liability management (ALM): Asset and liability management: managing the balance sheet as a whole so that the bank's earnings and value stay within agreed limits as interest rates, liquidity and funding change.
Asset and Liability Committee (ALCO): Asset and Liability Committee: the senior management committee, under the board, that sets and monitors the bank's interest rate, liquidity and funding positions.
Banking book: The loans, deposits, bonds and hedges a bank holds to collect interest or to fund itself, rather than to trade. Measured mostly at amortised cost.
Interest rate risk in the banking book (IRRBB): Interest rate risk in the banking book: the risk to a bank's earnings and capital from changes in interest rates, through its loans, deposits and hedges.
Fixed rate: A rate set for a period (a fix, a term or the life of a bond). The rate changes only when the period ends.
Floating rate: A rate that resets to a market index, such as Bank Rate or SONIA, at set dates.
Administered rate: A rate the bank sets and changes at its own discretion, such as a savings or current account rate. How much of a market move it passes on is the beta.
Deposit beta: Deposit beta (pass-through): the share of a change in the market rate that a bank passes on to an administered rate.
Net interest income (NII): Net interest income: interest earned on assets less interest paid on liabilities, plus the net result of interest rate hedges, over a period.
Net interest margin (NIM): Net interest margin: net interest income divided by total (or interest-earning) assets.
Economic value of equity (EVE): Economic value of equity: the present value of the bank's asset cash flows less that of its liability cash flows, with hedges, at market rates. Equity itself is left out.
Macro hedge: Macro hedge: interest rate swaps that cover a portfolio, such as fixed-rate mortgages, rather than one loan.
Structural hedge: Structural hedge: receive-fixed swaps that turn the bank's stable, rate-insensitive balances (current accounts, equity) into a steady fixed income.
Risk limit: Risk limit: the largest exposure the board allows, for example the fall in NII or EVE under a set of rate shocks.

Deep Dives & Origins

Deep Dives

Basel Committee on Banking Supervision, Basel Framework, SRP31 Interest rate risk in the banking book, BIS, version in force from 1 January 2026: Principles 1 to 4 on governance, risk appetite and measurement. Intermediate.
Basel Committee on Banking Supervision, Principles for the Management and Supervision of Interest Rate Risk, BIS, July 2004: the earnings and economic value perspectives (paragraphs 18 to 21). Intermediate.

Origins

Basel Committee on Banking Supervision, Basel Framework, SRP31 Interest rate risk in the banking book, paragraphs 31.10, 31.12, 31.14, 31.15, 31.22, 31.23, 31.28 and 31.29, BIS, version in force from 1 January 2026.
Basel Committee on Banking Supervision, Basel Framework, DIS70 Interest rate risk in the banking book (Table IRRBBA and Template IRRBB1), BIS, version effective 15 December 2019.
Basel Committee on Banking Supervision, Principles for the Management and Supervision of Interest Rate Risk, BIS, July 2004.
Furness Building Society, ALCO Terms of Reference (Assets and Liabilities Committee), October 2023.

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