In finance, an asset–liability mismatch occurs when the financial terms of an institution's

assets In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can ...

and liabilities do not correspond. Several types of mismatches are possible. For example, a bank that chose to borrow entirely in US dollars and lend in Russian

ruble The ruble (American English) or rouble (Commonwealth English) (; rus, рубль, p=rublʲ) is the currency unit of Belarus and Russia. Historically, it was the currency of the Russian Empire and of the Soviet Union. , currencies named ''rub ...

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 is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debto ...

, liquidity problems and wealth transfer. A bank could also have substantial long-term assets (such as

fixed-rate mortgage A fixed-rate mortgage (FRM) is a mortgage loan where the interest rate on the note remains the same through the term of the loan, as opposed to loans where the interest rate may adjust or "float". As a result, payment amounts and the duration of ...

s) funded by short-term liabilities, such as

deposits A deposit account is a bank account maintained by a financial institution in which a customer can deposit and withdraw money. Deposit accounts can be savings accounts, current accounts or any of several other types of accounts explained below. ...

. If short-term interest rates rise, the short-term liabilities re-price at maturity, while the yield on the longer-term, fixed-rate assets remains unchanged. Income from the longer-term assets remains unchanged, while the cost of the newly re-priced liabilities funding these assets increases. This is sometimes called a maturity mismatch, which can be measured by the duration gap. An interest rate mismatch occurs when a bank borrows at one

interest rate An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, t ...

but lends at another. For example, a bank might borrow money by issuing

floating interest rate A floating interest rate, also known as a variable or adjustable rate, refers to any type of debt instrument, such as a loan, bond, mortgage, or credit, that does not have a fixed rate of interest over the life of the instrument. Floating intere ...

bonds, but lend money with

s. If interest rates rise, the bank must increase the interest it pays to its bondholders, even though the interest it earns on its mortgages has not increased. Mismatches are handled by

asset liability management Asset and liability management (often abbreviated ALM) is the practice of managing financial risks that arise due to mismatches between the assets and liabilities as part of an investment strategy in financial accounting. ALM sits between risk ...

. Asset–liability mismatches are 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 A bank run or run on the bank occurs when many clients withdraw their money from a bank, because they believe the bank may cease to function in the near future. In other words, it is when, in a fractional-reserve banking system (where banks no ...

. 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 A hedge or hedgerow is a line of closely spaced shrubs and sometimes trees, planted and trained to form a barrier or to mark the boundary of an area, such as between neighbouring properties. Hedges that are used to separate a road from adjoi ...

References

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Definition of asset-liability mismatch
{{DEFAULTSORT:Asset-liability mismatch Banking Financial accounting Liability (financial accounting) Asset

See also

References