Unit 36: Asset–Liability Management and Interest Rate Risk

Where This Unit Fits

This unit follows Unit 35: Treasury and Liquidity Management by moving from short-term cash, reserves, and funding capacity into the broader balance sheet coordination processes banks use to manage interest rate exposure and structural financial sensitivity over time.

While liquidity management focuses on whether the bank can meet near-term obligations and funding demands, asset–liability management focuses on how assets and liabilities behave across changing rate environments, repricing cycles, maturities, and funding conditions.

Students now examine how banks align balance sheet structure, manage duration mismatch, evaluate rate sensitivity, and monitor how interest rate movements affect earnings, funding costs, and institutional stability.

Unit Overview

Banks hold assets and liabilities that often reprice at different times, mature on different schedules, and respond differently to changes in market interest rates. These structural mismatches create earnings volatility, funding pressure, and balance sheet risk if they are not actively monitored and managed.

This unit introduces the operational mechanics of asset–liability management by examining duration mismatch, repricing gaps, funding sensitivity, net interest income exposure, and the internal governance processes banks use to manage balance sheet risk.

Students learn how banks measure interest rate sensitivity, assess how deposits and loans behave under changing conditions, and use asset–liability management frameworks to support prudent balance sheet decision-making.

Why This Matters in Banking Operations

Interest rate movements can materially affect a bank’s earnings, funding costs, asset values, and long-term financial flexibility. Because banks transform deposits and other liabilities into loans and investments, they are naturally exposed to timing and pricing differences across both sides of the balance sheet.

Weak asset–liability management can lead to margin compression, unstable funding behavior, valuation pressure, or supervisory concern. Managing these exposures is therefore a central part of balance sheet discipline and institutional risk management.

In practical terms, this unit helps students understand how banks monitor interest rate risk, interpret balance sheet sensitivity, and make structural decisions that protect earnings stability and support sound financial management.

What You’ll Learn

Core Concepts

• How banks use asset–liability management to coordinate balance sheet structure
• Why duration mismatch creates interest rate sensitivity across assets and liabilities
• How funding sensitivity affects deposit costs, margin performance, and balance sheet behavior
• How changing rates influence earnings, economic value, and institutional flexibility
• Why governance and measurement frameworks are essential to managing interest rate risk

Operational Competencies

• Identify how asset and liability repricing differences create exposure
• Explain how duration and maturity structure affect interest rate risk
• Recognize how deposits, loans, and investments respond differently to changing rate environments
• Describe how banks monitor net interest income sensitivity and structural balance sheet risk

Institutional Questions This Unit Helps Answer

• How do banks manage interest rate exposure across the balance sheet?
• Why does duration mismatch matter in banking?
• How do funding costs and deposit behavior affect bank sensitivity to rates?
• What role does asset–liability management play in institutional stability?

Lessons in This Unit

Asset–Liability Management Foundations

• Lesson 36.1: What Asset–Liability Management Does

  Learn how asset–liability management coordinates balance sheet structure, interest sensitivity, and financial stability in banks.

• Lesson 36.2: Duration Mismatch and Repricing Gap Exposure

  Study how differences in asset and liability timing create rate sensitivity across earnings, valuation, and funding structures.

• Lesson 36.3: Interest Rate Risk in Loans, Deposits, and Investments

  Examine how core banking products respond differently to changing rates and how those responses shape overall institutional exposure.

Balance Sheet Sensitivity and Risk Governance

• Lesson 36.4: Funding Sensitivity and Deposit Repricing Behavior

  Understand how deposit costs, customer behavior, and funding mix affect margin stability and liability-side interest rate exposure.

• Lesson 36.5: Net Interest Income and Economic Value Sensitivity

  Study how banks evaluate the effect of rate changes on earnings outlook, asset values, and long-term balance sheet performance.

• Lesson 36.6: Balance Sheet Management, Limits, and ALM Governance

  Learn how banks use policies, committees, scenario analysis, and risk limits to monitor and control structural interest rate exposure.

• Lesson 36.7: Interest Rate Risk in the Banking Operating Model

  Bring together duration mismatch, repricing behavior, funding sensitivity, and balance sheet management into a complete view of interest rate risk in banking operations.

Connected Units

• Unit 3: Bank Balance Sheets and Accounting

  Revisit how asset composition, liability structure, and balance sheet mechanics create the foundation for asset–liability management.

• Unit 35: Treasury and Liquidity Management

  Connect short-term liquidity oversight with the longer-horizon balance sheet and interest sensitivity issues covered in this unit.

• Unit 28: Credit Risk Management

  Compare credit exposure in the loan portfolio with the structural interest rate and funding exposures managed through ALM frameworks.

Study Support

• Templates & Tools

  Use repricing gap templates, duration mapping worksheets, rate sensitivity examples, and balance sheet analysis tools to understand ALM operations.

• Glossary Support

  Review key terms such as asset–liability management, duration, repricing gap, net interest income, economic value sensitivity, deposit beta, and rate shock.

• Case Examples

  Study examples showing how banks respond to rising rates, falling rates, margin pressure, funding repricing, and balance sheet mismatch.

Practical Application

By the end of this unit, students should understand how banks manage structural interest rate exposure through asset–liability management, funding sensitivity analysis, and balance sheet monitoring. They should be able to explain how duration mismatch and repricing differences affect earnings stability, funding performance, and institutional risk.

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