Asset liability mismatch

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Asset liability mismatch

In finance, an asset-liability mismatch occurs when the financial terms of the assets and liabilities do not correspond. For example, a bank that chose to borrow entirely in U.S. dollars and lend in Russian ruble

Ruble

File:Banknote 5000 rubles front.jpgFile:100000 rubles Belarus 2000 obverse.jpgFile:Transnistria rubla 2000.jpgThe ruble or rouble is a unit of currency....
s would have a significant (currency) mismatch: if the value of the ruble were to fall dramatically, the bank would lose money. In extreme cases, such movements in the value of the assets and liabilities could lead to bankruptcy

Bankruptcy

Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay its creditors. Creditors may file a bankruptcy petition against a debtor in an effort to recoup a portion of what they are owed or initiate a restructuring....
, liquidity problems and wealth transfer.

Asset-liability mismatches can occur in several different areas.

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Ruble

Bankruptcy

Fixed rate mortgage

A fixed rate mortgage is a mortgage loan where the interest rate on the Promissory note remains the same through the term of the loan, as opposed to loans where the interest rate may adjust or "float." Other forms of mortgage loan include interest only mortgage, Graduated payment mortgage loan, variable rate mortgage , negative amortizatio...
s) but short-term liabilities (maturity mismatch), such as deposits, which can be measured by the duration gap

Duration gap

The duration gap is a financial and accounting term for the difference between the Bond duration of assets and liability, and is typically used by banks, pension funds, or other financial institutions to measure their risk due to changes in the interest rate....
. Alternatively, a bank could have all of its liabilities as floating interest rate

Floating interest rate

A floating interest rate, also known as a variable rate or adjustable rate, refers to any type debt instrument, such as a loan, Bond , mortgage, or credit, that does not have a fixed interest of interest over the life of the instrument....
bonds, but assets in fixed rate instruments. Mismatches are handled by Asset liability management

Asset liability management

In banking, asset liability management is the practice of managing risks that arise due to mismatches between the assets and liabilities of the bank....
.

Asset-liability mismatches are also important to insurance companies and various pension plans, which may have long-term liabilities (promises to pay the insured or pension plan participants) that must be backed by assets. Choosing assets that are appropriately matched to their financial obligations is therefore an important part of their long-term strategy.

Few companies or financial institutions have perfect matches between their assets and liabilities. In particular, the mismatch between the maturities of banks' deposits and loans makes banks susceptible to bank runs

Bank run

A bank run occurs when a large number of bank customers withdraw their Deposit account because they believe the bank is, or might become, insolvency....
. On the other hand, 'controlled' mismatch, such as between short-term deposits and somewhat longer-term, higher-interest loans to customers is central to many financial institutions' business model.

Asset-liability mismatches can be controlled, mitigated or hedge

Hedge (finance)

In finance, a hedge is a position established in one market in an attempt to offset exposure to the price Risk#In_finance of an equal but opposite obligation or position in another market ? usually, but not always, in the context of one's commercial activity....
d.

Asset liability mismatch

See also