This document discusses asset liability management (ALM) in Islamic banking. It defines assets, liabilities, and equity for banks. Assets represent what banks own, like cash, loans, investments, and property. Liabilities are what banks owe, such as deposits and other borrowings. Equity refers to shareholders' ownership interest. ALM coordinates relationships between sources of funds (liabilities and equity) and uses of funds (assets) while managing risks. It ensures adequate liquidity and spreads between interest earned and paid. ALM is crucial for risk management in Islamic banks due to restrictions on interest and asset-liability mismatches.

1. UNDERSTANDING THE ASSET
LIABILITY MANAGEMENT (ALM)
o Assets and liabilities structure in Islamic Banking
o Technical instrument of ALM
o Liabilities and shareholders’ equity

2. Assets =indicate what the banks own
Liabilities =represent what the banks owe
Equity =refers to the owners’ interest
To simplify, liabilities and equity indicate sources of funds, whereas
assets means users of funds
ASSETS=LIABILITIES +EQUITY

3. Asset Liability Management
• Today, financial institutions are exposed to several risk, such as
liquidity risk, interest rate risk, credit risk and operational risk.
• Compared to two decade ago, financial institutions primarily faced
credit risk and market risk only
• By looking at these risk, ALM is very crucial for financial institutions.
There are several phases of evolution of ALM in Malaysia, and today,
ALM is considered a strategic management tool to manage interest
rate and liquidity risk.
• ALM is responsible not only for the acquisition of funds (liability
management), but also for effective allocation of those funds (assets
management)

4. To simplify, ALM coordinates the interrelationship between
the sources and uses of funds and deals with constraints such
as:
oUncertainties about seasonal deposits and loans flows
oLocal, national and international economic conditions
oMonetary policy effects on the money supply and level of
interest rates
oCustomers’ usage of lines of credits
oRegulations and policies imposed by management
Asset Liability Management

5. • In conventional financial institutions, ALM is the process of managing
the spread between interest earned and interest paid, while ensuring
adequate liquidity.
• According to Islamic Financial institution is less exposed to assets and
liabilities mismatch, and therefore to instability, compared to its
conventional counterpart. The assets and liabilities are matched as a
result of the “pass through” structure.
Asset Liability Management

6. Assets
In general, a banks’ assets are grouped into four categories:
1. Cash in the vault and deposits held at other depository institutions
2. Loans and lease financings made available to the customers
3. Investment securities
4. Miscellaneous assets
A banks’ assets are the banks’ uses of funds which are made to
generate income for its shareholders, pay interest to its depositors, and
pay its employees for their labour and skills

7. Cash in the vault and deposits held at other depository institutions
• In order to meet deposit withdrawals, customers’ demands for loans
and other unexpected or immediate cash needs, cash assets are
designed to meet the liquidity needs of the bank.
• Cash assets consist of vault cash, deposits held at Bank Negara
Malaysia and deposits held at other financial institutions

8. Loan and financing
• In conventional banking system, loans are the major items on a banks’
balance sheet which generate the greatest flow of income
• Furthermore, loans are the major source of credit where the banks
may face liquidity risk in managing its liquidity requirements
• In other hand, Islamic banks face two main problems:
1. To match flat rate profit for financing with floating profit rate for the
sources of funds
2. To manage liquidity needs of the banks against the financing given
to the customers

9. Investment Securities
• Investment securities are backup source of liquidity and include investment
that provide a source of income
• These securities are highly liquid, have low default risk, and can usually be
traded in a secondary market
• Some of the securities cannot be sold immediately but can be pledged
against certain types of borrowing by the bank
• In order to meet the liquidity need easily, bank generally maintain a
significant amount of these securities
• Islamic finance has various types of investment securities, normally
referred to as sukuk or Islamic commercial papers.
• The tradability of the sukuks at secondary market depends on the
underlying contract.
• Not all sukuks can be traded in secondary market since they may fall under
prohibited debt trading

10. Miscellaneous assets
• Miscellaneous assets consist of items such as premises and fixed
assets, investment in other subsidiaries, intangible assets and other
assets.

11. Liabilities and Shareholders’ Equity
• Liabilities consist of two main categories:
1. Deposit made by and owned to various customers
2. Non-deposit borrowings of funds in and from money and capital markets
• The principal liability of any bank is its deposits, representing financial
claim held by businesses, households, and the government against the
banks
• A banks’ liabilities consist of various types of deposit accounts and other
borrowings used to fund the investments and loans on the asset side of the
balance sheet. Liabilities vary in terms of their maturity, interest payments.
• Islamic banking systems is slightly different from the conventional system,
as the liabilities come from deposits and profit sharing investments from
the investors to finance retail and corporate financing on the asset side of
the balance sheet with various maturity dates.

12. oanother source of banks’ funding is the equity components.
oEquity capital represents long-term funds that the owner
(shareholders) contribute to the business (banks).
oIn other words, capital or equity represents ownership interests in the
banks.
oIn fact, every bank starts with a minimum amount of owners’ capital
and then borrows from the public (IPO) to lever up its operations.
oBanks are among the most heavily leveraged (debt-financed) of all
business.
Liabilities and Shareholders’ Equity