Concepts of Bank Funds Management

Abstract

Bank "funds management" is the key to short-to-intermediate decision making in the dynamic and volatile banking environment. Broadly defined, funds management includes all policies and approaches designed to obtain funds from deposits and borrowings and to allocate them to loans and investments. More specifically, the emphasis in funds management is on the funds over which management has discretionary control -- these are prime;ly assets and liabilities bought and sold in impersonal financial markets.

In recent years, several terms have been used to describe approaches to funds management. Often, these terms have (e.g., "balance sheet management" and "asset/liability management") are used interchangeably with funds management. To provide more specific differentiation between these terms, it is useful to define them consistent with their original usage and to consider them as approaches within the framework of funds management. Thus, the concept of funds management may be thought of as incorporating two major systems-oriented approaches: (1) "dynamic balance sheet management" -- application of optimizing management science models to funds management in a multi-period context, and (2) asset/liability management -- application of deterministic, computer-based financial planning models to funds management in a short-term context. These approaches should be applied consistent with the basic objective of "wealth management."

Two other approaches are often associated with funds management: interest rate forecasting models and specific application management science models. These models are designed to solve specific banking problems and/or are incorporated in more general or systems-oriented approaches to funds management.

Asset/liability management is the primary focus of bank funds management today. While bank asset/liability committees differ in their approaches to funds management, the essence of asset/liability management is to coordinate the interrelationships between the sources and uses of funds in short-term financial planning and decision making.It also requires the need for an overall view of the bank, an understanding of the assumptions that underlie decisions, and awareness of the sensitivity of the desired results of decisions to changes in these assumptions (e.g., interest rates). The short-to-intermediate-term results sought in asset/liability decisions should also be consistent with the objectives sought in the bank's strategic long-term plan.

The time horizon for asset/liability management decisions is typically from one to six or twelve months.This contrasts with the even shorter time horizon for decisions concerning legal reserve requirements and the long horizon necessary to implement major changes in the basic elements of the bank -- structure, customer base, major asset/liability components and composition, earnings retention, and capital structure.

The individual sections include discussions of wealth maximization, balance sheet management, linear programming models, asset liability management, financial planning models, and "gap management."