ALM risks, liquidity and funding: a supervisory framework for resilience and stability

Keynote speech by Patrick Montagner, Member of the Supervisory Board of the ECB, at the 2025 SSM conference on asset liability management

Frankfurt am Main, 1 July 2025

Welcome to the 2025 Single Supervisory Mechanism (SSM) conference on asset liability management, hosted by the ECB. This conference comes at a pivotal time for the financial sector. Over the past several years, we have witnessed a profound shift in the financial landscape. Rising interest rates and quantitative tightening have succeeded a decade of low interest rates and ample liquidity. These changes bring both challenges and opportunities for banks, particularly in the critical area of asset liability management, or ALM. This is therefore a good time for industry and supervisors to reflect and exchange views on the implications of the recent trends.

At its core, ALM captures all financial risks arising from mismatches between a bank’s assets and liabilities in terms of timing, value or currency. It encompasses liquidity and funding risks, interest rate risk, credit spread risk and structural currency risk. In the case of significant banks, net interest income makes up two-thirds of their operating income on average, underscoring the importance of sound ALM practices for long-term profitability.

This is all the more true under a changing interest rate and liquidity regime and in an environment of geopolitical uncertainty, where appropriate interest rate positioning and sustained access to diversified funding and liquidity pools can make a material difference.

This is why we see sound measurement and management of assets and liabilities as a key factor in banks’ long-term sustainability and welcome the opportunity to discuss this topic with you today.

ECB Banking Supervision has identified the management of interest rate and credit spread shocks, funding plans, and ALM frameworks as supervisory priorities since 2022.^[1] This led the ECB to undertake several off-site and on-site initiatives and reviews of ALM governance and strategies.

Today I will focus on three key areas: (i) evolving ALM risks in the current macroeconomic environment, (ii) sound practices and key supervisory findings identified in our reviews, and (iii) the importance of operational readiness to access central bank liquidity facilities.

I will also remind you how important it is for banks to make use of central bank liquidity operations and how they need to build operational capabilities to access these facilities, as stipulated in a recent blog post by Claudia Buch, Chair of the Supervisory Board of the ECB, and Isabel Schnabel, Member of the Executive Board of the ECB.^[2]

I hope we will leave this conference with a shared understanding of how to strengthen ALM practices and build resilience in this period of transformation.

ALM risks in the current macroeconomic environment

Over recent years, the financial sector has experienced a rapid transformation, driven by the normalisation of monetary policy and an evolving technological landscape. This transition will compel banks to reassess their funding strategies and liquidity management frameworks to navigate this new normal effectively.

This shift introduces new challenges for ALM positioning. Banks are dealing with increased interest rate convexity and credit spread volatility. In their investment strategies and funding planning they need to find a balance between flexibility, funding stability and expected returns.

Furthermore, clients – whether institutional, wholesale or retail – now have instant access to high-speed online 24/7 banking services, instant payments and other digital channels through which they can swiftly re-allocate their funds. A wide range of communication channels and social media increases the availability of information and the speed of its dissemination. This makes clients’ reactions faster and less predictable, as we saw during the events of March 2023, when intraday liquidity across legal entities was also important.^[3] Additionally, during the pandemic and the energy crisis we saw that there can be rather complicated margin dynamics both on the cleared and non-cleared sides.

For banks, this changed dynamic altogether complicates the assignment of behavioural maturities used to quantify interest rate and liquidity exposures. Many institutions have struggled to correctly estimate repricing patterns and behavioural assumptions, particularly in the face of structural shifts in client behaviour.

At the same time, the reversal of the interest rate tightening cycle has pushed some banks to extend the duration of their interest rate positions while reducing funding issuances in terms of size and maturity. This exposes them to greater risks from unexpected changes in interest rates or credit spreads.

Key supervisory findings and lessons learned

To assess and strengthen ALM practices in banks, the ECB conducted extensive reviews between 2022 and 2024. This included off-site reviews and several on-site investigations, our most intense and intrusive tool. These covered liquidity and funding risks, interest rate risk in the banking book (IRRBB) and credit spread risk in the banking book (CSRBB). We assessed ALM governance and strategies, risk measurement and modelling, funding and liquidity contingency planning, collateral mobilisation capabilities, and liquidity recovery options of the banks under European banking supervision. We also carried out a thematic review of select banks and intraday liquidity, and we have already published best practices in this area.^[4]

Our work allowed us to identify various good practices in ALM and liquidity management, as well as systematic shortcomings, which we will discuss in more detail in today’s conference.

Let me now highlight three key areas: governance, strategic ALM choices and risk identification and measurement.

Strong governance

Effective ALM governance is founded on reliable and timely information. Senior executives, and decision-makers need more than just raw data – they require insights that are transparent about assumptions and limitations. Integrated IT systems and robust data aggregation processes are critical for providing such insights.

However, good data do not guarantee good decision-making. Governance structures must ensure that alternative scenarios are considered, assumptions are challenged and plans remain flexible. We have seen good examples, where management bodies – in both their management and supervisory functions – and the Asset and Liability Committee, or ALCO, play active roles and properly consider related risks and alternatives in their decision-making.

Equally important is the three lines of defence framework, made up of (i) the business areas, (ii) risk management and compliance, and (iii) internal audit. The second line of defence, particularly the risk function, must provide independent opinions on the ALCO’s proposals and ensure that strategies include formal risk assessments. Internal audit, the third line, should regularly review ALM processes and ensure that specialised expertise is in place. 

Considerations when making strategic ALM choices 

As excess liquidity declines in the system, banks must adapt their medium and long-term funding plans. We expect these plans to include a detailed breakdown of funding sources, instruments and currencies while taking account of regulatory, legal and operational constraints. Banks must ensure that liquidity and collateral can be transferred effectively within the banking group across many jurisdictions, even under stressed conditions. The funding plans should be rigorously back-tested, with deviations documented and discussed by decision-makers to improve future planning.

During this period, banks should pay equal attention to liquidity steering. They should ensure that their risk identification and quantification processes are up to date, enabling them to anticipate channels of liquidity shocks, have adequate buffers (also over the weekend in the context of 24/7 instant payments) and take timely action.

Banks must also carefully evaluate their exposure to interest rate risks, including gap, basis and option risks. Alternative arrangements should be in place to address unexpected changes in interest rate markets. For instance, extending the duration of assets while reducing funding maturity can expose banks to significant liquidity and funding risks if market conditions shift unexpectedly.

We encourage banks to adopt robust credit spread strategies that anticipate pressures on credit spread differentials and funding costs.

Overall, ALM strategies should include a combination of quantitative limits and qualitative guidelines, tailored to the bank’s size, complexity, business model and risk appetite.

Risk identification and measurement

Regulatory metrics, such as the liquidity coverage ratio and the net stable funding ratio, and the supervisory outlier test regarding IRRBB provide a strong foundation for managing ALM risks. It is therefore crucial that institutions ensure these are calculated appropriately. In addition, as these metrics are standardised and cannot capture every idiosyncratic risk, banks must go beyond the regulatory requirements by developing additional risk metrics and stress scenarios tailored to the current market environment and its challenges.

A key aspect of ALM risk identification, measurement and reporting is the proper design and calibration of behavioural models used for modelling non-maturing deposits and loan prepayments. Despite significant supervisory focus over time, almost every time we take a closer look at behavioural models, we find significant deficiencies that hamper banks’ ability to appropriately measure and manage IRRBB and liquidity risks.

In this regard, we would like to reinforce the message that, in their modelling approaches, banks need to consider sufficiently long and appropriate time series that cover different interest rate environments and market-wide and/or idiosyncratic stress. Banks should also consider overlays and additional levels of conservatism to account for forward-looking risk factors and other dimensions that models cannot capture.

Institutions are expected to have in place granular ALM models that categorise deposits by characteristics such as account type, depositor profile, deposit size, and currency. Particularly in times of crisis, banks should apply prudent and conservative assumptions to capture customer behaviours, which, in the era of digitalisation, fintech and instant payments, are changing alongside the availability of information and the tools at clients’ disposal.

Stress testing and scenario analysis remain key to identifying vulnerabilities. Banks need to simulate diverse adverse scenarios – both idiosyncratic and market-wide – and integrate the results into contingency funding plans to ensure readiness during periods of stress.

Central bank operations: a vital tool for liquidity management

On the liquidity front, one significant challenge still remains and needs to be well understood.

For more than a decade, European banks have been operating in an environment of high excess liquidity. This liquidity was introduced into the banking system as the result of extraordinary actions taken by the ECB in its role as a central bank during the low interest rate period before and during the COVID-19 pandemic.

Since 2023 available excess liquidity has been decreasing at a steady pace owing to the gradual roll-off of the ECB’s monetary policy portfolios and large repayments of targeted longer-term refinancing operations (TLTROs). The latter was actually achieved by banks without a hitch thanks in part to our past prioritisation of TLTRO exit strategies.^[5] The natural consequence of this is the changing composition of banks’ liquidity buffers, which are moving away from central bank deposits and towards collateral. As well as adding interest rate risk and credit spread risk, this also means that assets held in the liquidity buffer are no longer immediately available to meet payment needs – collateral first needs to be monetised, either in repo markets or with central banks. However, after years of very high excess liquidity, our reviews have shown that not all banks are operationally ready to make this adjustment. In this context, I would like to underline two key messages in Claudia Buch and Isabel Schnabel’s blog post.

First, as excess liquidity is expected to sink to levels that will no longer be sufficient to meet the demands of the banking system, banks and investors should view standard ECB operations and facilities – such as the main refinancing operations – as tools to be used proactively in day-to-day liquidity management to maintain an appropriate balance between central bank deposits and collateral in liquidity buffers. In other words, supervisors will not view banks accessing ECB facilities as an indication of a lack of market access or a sign of stress.

Second, banks need to be operationally ready to access central bank operations and facilities effectively and seamlessly whenever needed. Banks must have the technical and procedural capacity to participate in central bank operations, including ensuring access to sufficient levels of eligible collateral, maintaining the necessary infrastructure and governance for transactions, and always meeting the central bank’s operational requirements.

In our review of the collateral identification and mobilisation capabilities of banks, we have seen several areas where there is room for improvement.

Some institutions are overly optimistic about the time required to monetise collateral. To avoid missteps, banks must assume realistic but conservative timelines. Internally, this means streamlining workflows and empowering teams to act swiftly when monetising collateral. Banks must also understand that central banks need time to assess collateral eligibility.

In addition, banks need to review their balance sheets systematically. Some banks already identify unencumbered, non-liquid assets – such as residential mortgages – that can be securitised to raise new funding. This practice should become standard, supported by robust monitoring indicators embedded in the bank’s risk appetite framework.

We will continue our dialogue with banks to strengthen their collateral management practices.

Conclusion

In summary, the evolving challenges in the banking sector demand a more rigorous approach to ALM and liquidity management. Strong governance, a refined strategy, robust planning, and enhanced risk identification and stress testing are the foundations of resilience. 

Banks must also make their use of central bank liquidity facilities more routine and ensure they are operationally ready to use these tools at any time.

I urge banks to take early action to address these challenges. This will help us build a more resilient and stable financial system for the future.

Today’s conference aims to delve deeper into these topics, exploring the implications of recent regulatory changes and discussing the future direction of ALM. It provides an excellent opportunity to exchange insights and collectively navigate the path forward.

Thank you for your attention. I look forward to the discussions ahead and the opportunity to engage with all of you.