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ALM in
Asset and liability management in financial crisis
financial crisis
Arzu Tektas, E. Nur Ozkan-Gunay and Gokhan Gunay
Department of International Trade, School of Applied Disciplines, 135
Boğaziçi University, Istanbul, Turkey
Abstract
Purpose – An efficient asset-liability management requires maximizing banks’ profit as well as
controlling and lowering various risks. This multi-objective decision problem aims to reach goals such
as maximization of liquidity, revenue, capital adequacy, and market share subject to financial, legal
requirements and institutional policies. This paper models asset and liability management (ALM) in
order to show how different managerial strategies affect the financial wellbeing of banks during crisis.
Design/methodology/approach – A goal programming model is developed and applied to two
medium-scale Turkish commercial banks with distinct risk-taking behavior. This article brings new
evidence on the performance of emerging market banks with different managerial philosophies by
comparing asset-liability management in crisis.
Findings – The study has shown how shifts in market perceptions can create trouble during crisis,
even if objective conditions have not changed.
Originality/value – The proposed model can provide optimal forecasts of asset-liability components
and banks’ financial standing for different risk-taking strategies under various economic scenarios.
This may facilitate the preparation of contingency plans and create a competitive advantage for bank
decision makers.
Keywords Assets management, Liability, Financial management, Banking, Turkey
Paper type Case study

Introduction
Internationalization and financial integration and have increased the possibility of
financial contagion among emerging and developed countries. The recent financial
crises in Asia, Russia, Latin America, and Turkey demonstrated the extent of
vulnerability in global financial markets to changes in emerging financial markets.
The significance of the banking sector in the smooth and efficient functioning of the
overall economy as well as the domestic financial system has become even more
apparent during these crises. Therefore, developing appropriate bank management
strategies seems crucial for lowering the devastating effects of crises.
A vital issue in strategic bank planning is asset and liability management (ALM),
which is the assessment and management of endogenous – financial, operational,
business – and exogenous risks. The objective of ALM is to maximize returns through
efficient fund allocation given an acceptable risk structure. ALM is a multidimensional
process, requiring simultaneous interactions among different dimensions. If the
simultaneous nature of ALM is discarded then decreasing risk in one dimension may
result in unexpected increases in other risks.
ALM has changed significantly in the past two decades with the growth and
integration of financial institutions and the emergence of new financial products and The Journal of Risk Finance
Vol. 6 No. 2, 2005
services. New information-based activities and financial innovation increased types of pp. 135-149
q Emerald Group Publishing Limited
1526-5943
This article is supported by Boğaziçi University Research Fund. DOI 10.1108/15265940510585806
JRF endogenous and exogenous risks as well as the correlation between these.
Consequently, the structure of balance sheet instruments has become more complex
6,2 and the volatility in the banking system has increased. These developments necessitate
the use of quantitative skills to manage risks more objectively and improve
performance:
Banking risk management is both a philosophical and operational issue. As a philosophical
136 issue, banking risk management is about attitudes toward risk and the pay off associated
with it, and strategies in dealing with them. As an operational issue, risk management is
about the identification and classification of banking risks, and methods and procedures to
measure, monitor and control them (Angelopoulos and Mourdoukoutas, 2001, p. 11).
Diversity in bank decision makers’ attitudes toward risk results in diverse ALM
strategies. Risk taker decision makers are willing to accept higher risk for higher
return whereas risk averse managers accept lower level of risks for lower return.
Consequences of high risk taking strategies might be more devastating in unstable
macroeconomic environments such as emerging financial markets, leading to systemic
banking crises. On the other hand, financial risks may also increase a bank’s overall
risk. Since this type of interdependency has been observed during the recent crises in
Turkey, it might be worthwhile to analyze ALM strategies with varying risk-taking
attitudes during the crises period in order to demonstrate the sensitivity of banks’
performance to different risk taking strategies.
The aim of the paper is to model ALM in order to show how different managerial
strategies affect the financial well being of banks during crisis. The goal programming
model is built on the managerial goals and policies of the bank along with financial and
regulatory conditions. It manages different risks such as liquidity, capital, credit,
currency, market and operational risks that comprise critical issues in emerging
financial markets. Banks carrying these risks and facing worsening economic
conditions could benefit using the proposed model by analyzing the consequences of
alternative options in asset-liability management. The model is applied to two medium
scale Turkish commercial banks, one risk-averse and the other risk-taker, for the crisis
year 2000 as a specific case of an emerging financial market.
The financial structure of the Turkish banking sector during crisis is discussed in
the next section. Banking literature on multi-objective decision making; methodology
and the model developed; empirical results and conclusion are discussed in consecutive
sections.

The Turkish banking sector in the crises years

The Turkish banking sector has faced challenges calling for restructuring with new
rules and regulations since 1980. During this period, Turkey experienced a number of
financial crises that severely hit the economy and the banking sector. Among these
crises, the recent twin crisis of November 2000 and February 2001 are the most severe
ones leading to a systemic banking crisis, in combination with a currency and an
economic crisis. Twin crises were due to a decade long macroeconomic problems such
as high inflation, high public sector borrowing, credit rationing in the private sector,
rapid growth of the banking sector without prudential regulatory institutions, foreign
exchange open positions in the banking system, and dominance of inefficient large
state banks (Ozkan-Gunay, 1998). At the end of 1999, the government announced an
economic program, “Disinflation Program”, based on a pre-determined exchange rate
path as a nominal anchor, tight fiscal and monetary policies, and important structural
reforms that were postponed for years. All economic agents demonstrated an ALM in
optimistic approach and the public fully supported the announced program. However,
the Economic Program failed in the last quarter of 2000 due to the political conflicts
financial crisis
prevailing in the coalition government and the delay in structural reforms. Foreign
investors transferred their funds abroad. The high foreign exchange demand and the
control of liquidity by the Central Bank led to the collapse of the payment system in the
banking sector. Especially the crash in large state banks had a chain effect in the 137
overall economy as well as in the banking sector. Public loss of trust resulted in sharp
declines in bond and stock prices and withdrawals from banks, triggering the twin
crises. The impacts of the twin crises were severe enough to justify government take
over, closing or partial intervention in 23 banks as of June 2002. In the real sector, many
small size enterprises went bankrupt and many large firms faced liquidity problems.
Under the above circumstances, the structural composition of assets and liabilities
changed in the balance sheets of the banks over the years. FX deposits became popular
because economic agents expected that the pre-determined exchange rate path and the
real appreciation of the Turkish Lira (TL) would lower costs of borrowing in FX
liabilities. On the other hand, the high public sector borrowing led to high interest rates
on government securities making these instruments more attractive for the banking
sector. Banks were carrying open FX positions because high domestic real interest
rates made it attractive to borrow abroad and buy government securities to finance
public sector deficit. The share of government securities in total assets increased from
10 percent in 1990 to 23 percent in 1999 (The Banking Regulation and Supervision
Agency, 2001). The real sector was crowded-out. The credit to gross national product
(GNP) ratio was about 25 percent, the lowest among all emerging market economies
(The Banking Regulation and Supervision Agency, 2001). As a result, the share of the
liquid assets declined while the share of government securities and loans, especially
consumer credits increased in bank balance sheets. A mismatch of maturities resulted
from an increase in short-term bank funding sources in liabilities as well as an increase
in the percentage of FX liabilities in total liabilities.
The unexpected factors affected the sector’s as well as the banks’ financial
performance. Deteriorating financial ratios in the banking sector make the impact of
the crisis apparent (Table I). An important characteristic of 2000 is banks’ preference to
carry a high ratio of government securities in their portfolio. Although the securities
have high returns, they can be considered as risky investment due to liquidation
problems. It would be difficult to resell these securities in the secondary market due to
high loss especially during crisis. Decline in liquidity and government securities
portfolio figures is a consequence of this development. The decline in return on asset
(ROA) is the result of the imposition of a capital tax on government securities, the
increase in provisions due to increase in non-performing loans and the additional tax
because of the earthquake.
The vulnerability of the banking sector to economic distortions makes it worthwhile
to analyze the situation at individual bank level especially for banks with diverse
policies. Two medium scale banks operating in the Turkish banking sector are chosen
as representatives of distinct risk taking behaviors. These banks are referred to as risk
averse bank (RAB) and risk taker bank (RTB). Table I shows the financial standing of
RAB and RTB compared to sub groups of banks as well as the sector during the crisis.
RTB prefers to borrow short-term FX funds and lend in longer-term TL assets or buy
government securities. This creates a maturity mismatch and a high foreign exchange
open position in its balance sheet. RAB chooses to maintain high levels of liquidity and
 6,2
JRF

138

Table I.

banking sector (%)

Ratio analysis of the
Years State Private Foreign RAB RTB Sector

1999 11.7 17.2 22.5 10.1 22.4 8.2

Capital adequacy ratio (Shareholders’ equity/Total risk-weighted assets) 2000 7.8 18.4 17.8 11.2 6.4 13.4
1999 23.2 43.5 63.6 59.7 39.8 35.9
Liquidity ratio ( Liquid assets/Total assets) 2000 18.3 36.5 59.1 50.6 35.8 32.1
1999 10.0 3.6 2.7 0.5 1.5 10.7
Credit risk (Non-performing loans/Total loans) 2000 12.5 6.1 2.9 0.9 5.5 11.5
1999 99.2 82.2 75.4 87.2 68.6 79.4
Currency risk (FX assets/FX liabilities) 2000 93.8 74.2 72.6 87.4 81.0 76.0
1999 1.5 5.6 8.2 3.9 8.8 20.6
Return on assets (Net income/Average total assets) 2000 1.2 0.7 0.7 2.8 2 5.6 2 3.1
1999 24.3 33.5 16.5 17.6 27.0 30.1
Assets quality (Total loans/Total assets) 2000 25.8 37.7 17.1 22.6 49.2 32.8
1999 109.8 171.6 175.8 224.7 175.1 129.5
Interest income/Interest expense 2000 114.0 177.5 158.1 219.2 106.3 129.6
1999 10.7 20.9 31.5 21.7 26.5 17.2
Share of government securities in total assets 2000 6.2 10.5 12.9 17.9 30.8 11.5
1999 39.8 46.4 2.7 0.6 2.3
Market share in deposits 2000 40.3 43.5 3.2 0.6 2.5
1999 28.2 55.1 2.9 0.5 2.0
Market share in loans 2000 27.0 54.5 2.8 0.7 3.6
1999 34.9 49.5 3.5 0.9 2.2
Market share in total assets 2000 34.2 47.4 3.6 1 2.4
Source: Banks in Turkey, 1999 and 2000
capital adequacy while giving high priority to the quality of their loan portfolios and ALM in
taking low currency risks. Financial performance of two banks relative to different
bank groups is summarized for pre-crisis and crisis year in Table I.
financial crisis
These figures indicate that RAB performed above sector average in most significant
performance measures such as capital adequacy, liquidity, credit risk, currency risk,
and return on assets in pre-crisis period. RAB did not experience any deterioration in
any of the measures despite the worsening ratios of the sector in the crisis year. Capital 139
adequacy of RAB improved from 10 percent to 11 percent and there was only a
minimal increase in its credit risk ratio from 0.5 percent to 0.9 percent compared to 11.5
percent risk ratio of the sector. On the other hand, RTB, which performed similar to
RAB before the crisis, experienced a sharp deterioration in all its measures. Capital
adequacy ratio of RTB decreased from 22 percent to 6 percent in the crisis year and the
credit risk ratio increased from 1.5 percent to 5.5 percent for the same bank. ROA ratios
of RAB showed little deviation with 4 percent and 3 percent for the years 1999 and
2000 compared to the respective values of 9 percent and 26 percent for RTB. RAB’s
government securities portfolio is approximately equal to the private banks’ average
level for both years; on the other hand, RTB’s securities portfolio is above the private
sector in 1999 and almost triple in 2000. Neither RAB nor RTB market shares in
deposits, loans, and total assets show any significant difference before and during
crisis.
Since the vulnerability of the Turkish economy affects the banking sector deeply,
bank managers in Turkey should consider various scenarios in preparing their
proforma budgets. In this paper, a multi-objective decision model is suggested as a tool
to that end. The proposed model can provide optimal forecasts of asset-liability
components and bank’s financial standing for different risk taking strategies under
various economic scenarios. This may facilitate the preparation of contingency plans
and create a competitive advantage for bank decision makers.

Banking literature on multi-objective decision making

The literature has recorded a number of mathematical programming models to
coordinate asset-liability planning using optimal decision strategies. The models have
been single or multiple goal, deterministic or stochastic. Deterministic models have
found more acceptability because of practitioners’ unfamiliarity and computational
difficulties related with stochastic models. The operational models assume that a bank
seeks to maximize its expected profits subject to portfolio mix constraints. Myers
(1968) and Hester and Pierce (1975) conclude that the appropriate objective function for
a financial institution involves maximization of the expected net present value.
The deterministic models follow the linear programming model approach of
Chambers and Charnes’ (1961). Their study maximizes net discounted returns, subject
to budget, liquidity and system constraints. Further applications of their model are
Cohen and Hammer (1967), Komar (1971). Single objective nature of these models
ignores the multiple objectives in banking decisions. Zopounidis (1999) justifies the
multi-criteria character of financial problems such as optimization of assets and
liabilities.
Goal programming and other multi-objective decision models have been applied to
banking by Forston and Dince (1977), Booth and Dash (1979), Eatman and Sealey
(1979), Korhonen (1987), Booth and Bessler (1988). Booth and Dash (1979), Booth and
Bessler (1988) and Korhonen (1987) address the multistage nature of the problem;
JRF Booth and Bessler (1988) take into account interest-rate risk as well. Forston and Dince
(1977) use a goal programming approach where four competing goals (profit,
6,2 loan-deposit ratio, capital adequacy, liquidity) are considered. Eatman and Sealey
(1979) consider three objectives, namely net profit maximization, capital-adequacy
ratio and risky assets-capital ratio minimization. Korhonen (1987) applies a two-stage
goal programming model to the management of domestic and foreign currency
140 dominated assets and liabilities of a bank. The goals deal with expected profits, risk,
liquidity, capital adequacy, growth and other aspects of the bank’s operations. Giokas
and Vassiloglou (1991) discuss the construction and application of a goal programming
model that takes into account the essential institutional, financial, legal and bank
policy considerations.
Among major studies on bank asset-liability management in the Turkish banking
sector, Oğuzsoy and Güven (1997) develop a stochastic linear model, which determines
the portfolio of assets and liabilities given a set of deterministic rate of returns and
costs of borrowings and a set of random deposit levels, liquidity, and total reserve
requirements. Güven and Persentili (1997) develop a linear programming model, which
aims at determining an optimal sequence of balance sheet positions for a bank. Both
models are implemented using Turkish banking sector data for 1987-1990 period.

Methodology
There is no way simultaneously to maximize returns (or profits) and minimize risks
but banks can only make risk/return tradeoffs and attempt to maximize returns for
whatever aggregate level of risk they choose to undertake (Uyemura and Van
Deventer, 1993). The objective of goal programming is to reach a satisfactory level of
multiple objectives whenever it is not possible to achieve every goal to the full extent,
so that the decision maker may come as close as possible to reaching goals.
Goal programming model (GP) is preferred to find the optimal composition of a
bank’s assets and liabilities in the Turkish banking sector. Choice of GP best describes
the multi-objective nature of the problem and it eliminates the computational
difficulties as well as practitioner’s unfamiliarity experienced with stochastic models.
Flexible nature of GP enables the decision maker to incorporate a number of goals
under a set of constraints. GP minimizes deviations between set goals and what can
actually be achieved within the given constraints.
In GP, the objective function (1) minimizes the sum of deviations (di) from each goal
(Gi). Each goal is assigned a priority weight (Pi) that shows its relative importance
among other goals. Therefore, goals with higher Pi values are achieved before the
others. The goals (2) reflect the objectives that are set by decision makers. Constraints
(3) represent the availability or upper/lower limits of resources.
Determine X ¼ ðx1 ; x2 ; . . .; xj ; . . .xn Þ such that:

 XI

Min Z ¼ f dþ 2
i ; di ¼ P i dþ 2
i ; di ð1Þ
i¼1

subject to:
X
n
þ
Goals ðG i Þ aij xj þ d 2
i 2 d i ¼ bi for i ¼ 1; :::; I : ð2Þ
j¼1
 X
n
Constraints cmj xj # r m for m ¼ 1; :::; M ð3Þ ALM in
j¼1 financial crisis
where:
xj: mean value of variable j;
aij: technological coefficient of xj in goal i; 141
b i: target value of goal i;
cmj: consumption coefficient of xj in constraint m;
rm: available amount of resource m;
dþ
i : overachievement of the target for goal i;
d2
i : underachievement of the target for goal i; and
P i: priority weight of the deviation variables of goal i.

Asset-liability management model (ALMM)

GP is applied to the Turkish banking sector taking into account sector specific
characteristics. The ultimate aim is to identify the best possible composition of a
bank’s assets and liabilities by controlling the various types of risks. The model
contributes to similar studies in literature by including emerging financial market
specific goals and constraints as well as testing the sensitivity of bank performances
for different risk taking strategies during crisis.
ALMM is developed as follows:

Min Z ¼ P 1 d2 2 2 2 2 2
1 þ P 2 d 2 þ P 3 d 3 þ P 4TL d 4TL þ P 4FX d 4FX þ P 5TL d 5TL
þ P 5FX d2 2
5FX þ P 6 d 6

subject to:
(1) Goals:
þ
.
G1: Liquidity – (Liquid assets/Total assets) þ d21 2 d 1 ¼ a.
.
G2: Revenue – (Total interest income 2 Total interest expense) þ
þ
d2
2 2 d 2 ¼ b.
.
G3: Capital adequacy – (Shareholders equity/Total risk weighted assets) þ
þ
d2
3 2 d 3 ¼ c.
.
G4TL: DepositTL market share – (Total TL depositsbank i/Total
þ
TL depositssector)þ d2 4TL 2 d4TL ¼ d.
.
G4FX: DepositFX market share – (Total FX depositsbank i/Total FX
þ
epositssector) þ d 2
4FX 2 d 4FX ¼ e.
.
G5TL: LoanTL market share – (Total TL loanbank i/Total TL loansector) þ
þ
d2
5TL 2 d 5TL ¼ f .
.
G5FX: LoanFX market share – (Total FX loanbank i/Total FX loansector) þ
þ
d2
5FX 2 d 5FX ¼ g.
þ
.
G6: Total asset – Total assets þ d 2 6 2 d 6 ¼ h.
JRF (2) Environmental constraints:
6,2 .
E1: Capital Adequacy ratio $ 8 percent.
.
E2: TL reserve requirement/TL total deposits $ 6 percent.
.
E3: FX reserve requirement / FX total deposits $ 11 percent.
.
E4: Disponibility for TL $ 2 percent.
142 .
E5: Disponibility for FX $ 2 percent.
.
E6: Disponibility for government bonds as legal reserves $ 4 percent TL
deposits þ 1 percent FX deposits.
.
E7: Shareholders equity/Total liabilities $ 5 percent.
.
E8: Total loans/Total assets $ 30 percent.

(3) Bank policy constraints:

.
P1: Market risk – a # Securities=Total assets # b.
.
P2: Currency risk – t # FX assets=FX liabilities # d:
.
P3: Currency risk – 1 # TL assets=Total assets # f:
.
P4: Credit risk – g # Non 2 performing loans=Total loans # h.
.
P5: Interest rate risk – Short termloans=Total loans $ w.
.
P6: Liquidity risk – TL cash=Total TL assets $ l.
.
P7: Liquidity risk – FX cash=Total FX assets $ u:
.
P8: Liquidity risk – TL due from banks=Total TL assets $ r.
.
P9: Liquidity risk – FX due from banks=Total FX assets $ v.
. P10: Liquidity risk – Liquid assets=Total deposits $ m.
.
P11: Liquidity risk – Current assets 2 Current liabilities/Total assets $ p.
.
P12: Operational risk – Fixed assets=Total assets # s:
.
P13: Operational risk – Operating expenses=Total assets # c:

(4) Technical constraint. T1: Total assets ¼ Total liabilities.

The ratios defined in goals and constraints are operationalized using decision variables
that are generally accepted balance sheet items of a Turkish bank (Table II). As an
example, G1 is operationalized as:

X1TL þ X1FX þ X2TL þ X2FX þ X3TL þ X3FX þ ::: þ X11TL þ X11FX

$a
Y 1TL þ Y 1FX þ Y 2TL þ Y 2FX þ Y 3TL þ Y 3FX þ ::: þ Y 11TL þ Y 11FX
where a is set as 0.40 by RAB and 0.30 by RTB.
Goals (G1-G6) are defined as meeting minimum levels of liquidity, revenue,
capital adequacy as well as market shares in total assets, deposit and loan, both TL
and FX. Right-hand-side values of goals are determined based on the related bank’s
policies.
Constraints are classified as environmental and bank policy constraints.
Environmental constraints include the regulatory constraints imposed by the
monetary authorities and the market driven constraints. Based on Basel risk-based
 Risk-averse bank Risk-taker bank
ALM in
Decision variables OS PS Actual OS PS Actual financial crisis
X1TL Cash TL 2.6 2.4 3 7 8.2 16
X1FX Cash FX 34.4 27.7 40 15.6 50.2 27
X2TL Due from banks TL 26.6 23.6 73 47.2 62.5 37
X2FX Due from banks FX 172.1 138.3 316 46.7 104 77 143
X3TL Central bank TL 2.6 2.2 2 12 6.8 4
X3FX Central bank FX 15 12.3 3 40 38.5 10
X4TL Other financial institutions TL 0 0 0 0
X4FX Other financial institutions FX 0 0 0 0
X5TL Interbank funds sold TL 17.6 14.6 60 574.6 193.1 16
X5FX Interbank funds sold FX 525.5 354 207 205.6 680.1 0
X6TL Government securities TL 237.1 237 1 827 827 783
X6FX Government securities FX 121.1 121 5 368 368 289
X8 Other securities 0 0 0 0 0 77
X9TL Reserve requirements TL 7.9 6.5 3 36 20.4 0
X9FX Reserve requirements FX 82.5 67.7 60 220 201.7 1
X10TL Short-term loans TL 352.9 247.9 100 668.4 608.4 741
X10FX Short-term loans FX 190.9 197.6 173 507.1 443.8 788
X11TL Long-term loans TL 0 43.3 53 0 0 288
X11FX Long-term loans FX 0 0 20 0 0 17
X12 Non-performing loans 11.1 6.2 3 47.5 47.5 100
X13 Equity participations (financial) 0 104 1 84 84 164
X14 Other participations 0 0 0 0 0 10
X15 Affiliated companies 0 0 298 66 66 168
X16 Fixed assets 0 0 13 100 100 140
Government bonds account funding
X17 legal reserves 12.8 10.5 0 32.8 0 44
X18 Accrued income 37 33 83 80 89.8 59
Y1TL Demand deposit TL 88.2 72.8 26 130 226.4 35
Y1FX Demand deposit FX 132.4 39.5 70 180 339.6 106
Y2TL Time deposit TL 44.1 36.2 89 470 113.2 1415
Y2FX Time deposit FX 617.6 576.4 470 1820 1584.7 995
Y3TL Interbank funds TL 0 0 1 0 0 45
Y3FX Interbank funds FX 0 105 0 0 0 0
Y4TL Central bank funds borrowed TL 0 0 0 0
Y4FX Central bank funds borrowed FX 0 150 0 0 0 0
Y5 Domestic bank funds borrowed 0 0 21 0 0 33
Y6 Abroad bank funds borrowed 518.5 150 424 659.6 686.7 578
Y7 Other funds borrowed 200.1 289 158 0 456 27
Y8 Accrued interest 56 45.2 67 130.4 122.3 75
Y9 Premium payable 4 4 4 48 48 70
Y10 Provision 15 15 15 144 144 31 Table II.
Y11 Shareholders’ equity 100 100 103 258 186 461 Empirical results under
Y12 Profit/loss 74 66 35 160 93 Loss different scenarios

capital criteria, banks should maintain a minimum capital adequacy level of 8 percent
against losses, which may result from existing and potential risks (R1). The Central
Bank of Turkey (The Central Bank of Turkey, 1996) requires a minimum TL and FX
reserve requirements of 4 percent (E2) and 11 percent (E3), respectively. Minimum TL
and FX disponibilities (required reserves for liability items excluding deposits and own
JRF funds) of 2 percent each (E4, E5) should be met. Disponibility for government bonds
6,2 should constitute at least the sum of 4 percent of TL and 1 percent of FX deposits (E6).
Finally, a minimum 5 percent ratio of shareholders’ equity to total liabilities (E7) and a
minimum 30 percent of total loans to total assets ratio (E8) are the generally accepted
principles in the Turkish banking sector.
Bank policy constraints capture the major risks present in emerging financial
144 markets. Their upper and lower limits reflect bank management strategies and can be
adjusted to changing preferences and environmental conditions. They are classified
information therefore they are not presented in the paper. Market risk includes external
factors such as environmental, political and monetary factors. Since high public sector
borrowing requirement has been an important constraint for the government, the
model controls market risk stemming from borrowing requirement by assigning upper
and lower limits on the government securities held by the bank (P1). Currency risk
shows the arbitrage between FX borrowing funds and TL asset items and is controlled
by imposing a range for the ratio of assets to liabilities in FX and TL (P2 and P3).
Credit risk represents the possibility of a delay in a repayment or no repayment of
credit. The constraint (P4) limits the ratio of non-performing loans to total loans.
Interest rate risk is the mismatch of maturities between short-term borrowings and
long-term lending as well as the pricing mismatch of the assets and liabilities in terms
of fixed and variable interest rate. The related constraint (P5) imposes a minimum level
on the amount of short-term loans. Liquidity shows how quickly assets can be
converted to cash to meet current obligations. Different types of liquid items such as
cash and due from banks are forced to maintain a minimum level (P6-P11). Operational
risk is controlled by maximum upper limits of fixed assets and operating expenses in
total assets (P12 and P13).
To demonstrate the impact of different risk taking behaviors on bank
performance during crisis, ALMM is run for two commercial banks with opposite
strategies. Risk behavior differences are reflected in the model by changing the
target levels of related goals and upper and lower limits of bank policy constraints
as shown in Table III.
Liquidity and capital adequacy goals are taken as indicators of attitudes towards
risk. Minimum compulsory risk levels for liquidity and capital adequacy are defined by
the monetary authorities. Although RTB suffices with these levels, RAB prefers to
keep higher ratios in order to lower its risk under unstable economic conditions. RTB
takes higher market risk by carrying higher volume of government securities in total
assets. On the other hand, RAB lowers currency risk by holding higher ratio of FX
assets. RAB is more sensitive to remain liquid therefore; it aims at higher ratio of liquid
assets in total assets.

G1 (%) G3 (%) P1 (%) P2 (%) P3 (%) P10 (%) P11 (%)

liquidity capital adeq. market currency currency liquidity liquidity
goal goal risk risk risk risk risk
Table III.
Risk behaviors of the RAB 40 10 15-20 80-90 25-35 70 8
representative banks RTB 30 8 25-35 45-60 65-75 25 5
Data and empirical results ALM in
Financial data for 1999 and 2000 were obtained from the annual publications of
Banking Association of Turkey. The data included the balance sheets and income
financial crisis
statements of the two banks analyzed in this paper. Face-to-face, semi-structured
interviews were carried with the vice-presidents of banks to collect data about bank
goals and strategies. Given the confidential nature of the required data, existing
network of contacts was used in order to reduce initial problems of access. They were 145
requested to provide information on the monetary and non-monetary targets of their
banks for pre-crisis and crisis periods. Information provided was used to structure
goals and bank policy constraints of each bank.
The year 2000 can be characterized as a break point in terms of realization of
expectations in the sector. It started with optimistic expectations based on the
Economic Program, but ended with unexpected crises due to failures in the
implementation of the announced program. Therefore, it is important to see the impact
of financial decisions made in the optimistic environment of the early 2000 on the
wellbeing of the banks under the worsening end of the year conditions. Therefore,
ALMM is run for two banks, RAB and RTB, for two different economic scenarios for
the crisis year 2000. First scenario is an optimistic scenario (OS), which assumes the
success of the Economic Program whereas the second one is a pessimistic scenario
(PS), assuming the failure of the Program. There are some major differences between
OS and PS versions of ALMM. In PS, the banks are expected to adjust their balance
sheet items accordingly. Revenue goal is affected because interest income and
expenditures change due to higher interest rates under deteriorating market
conditions. Economic agents prefer to remain more liquid under such conditions.
Besides, it is also assumed that the bank would not be able to resell the government
securities due to the high loss and/or the problems in the secondary market. Therefore,
lower limits of liquidity related constraints are reduced. An upper limit is imposed on
the amount of foreign borrowing due to the high premium risk at international
financial markets.
ALMM is run for RAB and RTB under both scenarios by assigning equal priority
weights for each goal. Results for OS, PS and the actual balance sheets of 2000 are
presented in Table II. Model results are discussed for RAB and then for RTB. Table IV
presents actual goals set by bank managers and model results defined as deviations
from the goals for RAB.
Two of the overachieved goals are liquidity and capital adequacy, which are
important indicators of risk-averse behavior. Liquidity is 5 percent; capital adequacy
ratio is 5 percent above the target and 7 percent above the Basel criteria. The market
share in TL deposits is also over-achieved by 6 percent and the market share in TL
loans is 18 percent above the target. Market share target of FX deposits and total assets

G1 G2 G3 G4TL G4FX G5TL G5FX G6

Goal 40% 136 10% 125 750 305 500 1,800

dþ 8% 0 5% 7.5 0 55 0 0 Table IV.
d2 0 19 0 0 0 0 230 0 Goal achievement levels
Note: Values other than G1 and G3 are in USD million for the risk-averse bank
JRF are just achieved. Interest revenue goal is under-achieved by 14 percent, the market
share in FX loans is 46 percent below the target.
6,2 Some major results of the bank policy constraints also strengthen the risk-averse
behavior of the bank. Liquidity risk measure (P10) is as high as 90 percent. This
implies that bank prefers to remain liquid while preferring high return liquid assets
such as lending FX in interbank and having FX accounts at other banks. Credit risk
146 measure (P4) is also minimized allowing at most 2 percent non-performing loans in
total loans. Measure of interest rate risk (P5) is as high as 98 percent. This behavior
shows that the bank is sensitive to maturity mismatch. Currency risk measure (P2) is
90 percent, implying that the bank is minimizing currency risk by avoiding the foreign
exchange open position. Results of OS show that 85 percent (USD750 million) of the
liabilities are collected in FX while 62 percent (USD1.148 million) of assets are kept as
FX. Market risk measure (P1) is low with a ratio of 19 percent government securities in
total assets. On the other hand, the model proposes to invest in TL government
securities due to the high returns and offers TL loans through open position. The
remaining FX liabilities are allocated in FX interbank funds and FX short-term loans in
the model. OS results in 4 percent ROA compared to 2.3 percent in the actual balance
sheet. A positive ROA is striking for the year 2000 compared to a sector average of
2 3.1 percent.
PS results for RAB show deteriorations compared to OS results. Liquidity ratio
drops from 48 percent to 39 percent, revenue decreases by 19 percent, total assets
shrink by 11 percent. Market share in TL deposits and TL loans, which are
overachieved in Run 1 are underachieved by 10 percent and 3 percent, respectively.
Since it is difficult to borrow abroad due to the country risk, the bank can use this
resource in a limited amount (USD150 million). Another difference is a 32 percent
decline of FX interbank funds sold along with an increase in long-term TL loans. There
is no considerable change in the remaining balance sheet items.
Related goal levels and constraint limits for RTB are given in Table III. Table V
presents OS results.
Capital adequacy is the only overachieved goal. Liquidity ratio is 1 percent below
the target. Interest revenue goal is under-achieved by 41 percent, indicating a lower
revenue level (USD145 million) than the target but it is still above the realized revenue
level of RAB. The market share in TL deposits, TL loans, and FX loans are also
under-achieved by 27 percent, 27 percent, 25 percent, respectively. It is difficult to
expand the deposit base in TL where approximately 60 percent of the deposits are held
in FX in the banking system. On the other hand, capital adequacy ratio of 10 percent is
7.5 percent above the target and 9.5 percent above the Basel criteria. The remaining
market share goals meet the target levels.
Considering the major implications of bank policy constraints under OS, RTB takes
high currency and interest rate risk to earn high profits. Currency risk measure (P2) is

G1 G2 G3 G4TL G4FX G5TL G5FX G6

Goal 35% 350 10% 825 2,000 914 675 4,000

Table V. dþ 0 0 7.5% 0 0 0 0 0
Goal achievement levels d2 1% 145 0 225 0 246 168 0
for the risk-taker bank Note: Values other than G1 and G3 are in USD million
53 percent, indicating higher open FX position compared to RAB’s 90 percent. 81 ALM in
percent (USD2,582 million) of the liabilities are collected in FX while 33.7 percent
(USD1,340 million) of assets are kept as FX. Liquidity measure (P10) of 53 percent is
financial crisis
lower compared to RAB’s rate of 90 percent. This implies that RTB might take higher
liquidity risk while preferring high return assets such as government securities and
having TL accounts at other banks. This preference is also indicated by a higher
market risk (P1) ratio of 30 percent compared to 19 percent ratio of RAB. 147
Owing to the expectations in the banking system, longer-term loans are offered
seldom, resulting in maturity mismatch, which also brings the interest rate risk
problem. In order to lower interest rate risk of 96 percent, the model proposes RTB to
allocate its FX liabilities 68 percent in FX time deposits, 25 percent foreign banks
borrowed and 7 percent FX demand deposit. On the asset side, non-performing loans,
which constitute 5.5 percent of total loans in actual (Table I), is 3.8 percent under OS.
When credit risk ratio is compared with the actual ratio of 5.5 percent, the model can
control this risk up to a certain level. OS results in 6 percent ROA but a negative return
of 2 5.6 percent is realized in the actual balance sheet for the year 2000 compared to a
sector average of 2 3.1 percent (Table I). This demonstrates that applying the same
strategies by using the proposed model can improve the performance.
Comparing the results of OS and PS for RTB, the main distinction is the decline in
liquidity and capital adequacy goal. Capital adequacy goal declines from 17.3 percent
to 13.5 percent and liquidity goal drops from 35 percent to 33 percent. Since RTB has a
large portfolio of government securities, it cannot sell in the secondary market due to
the liquidity problem in the market. Market share in deposits and loans are
underachieved significantly. Underachievement of the market share goals in TL
deposit, FX deposits, TL Loan, and FX loan are 58 percent, 4 percent, 33 percent, and
34 percent, respectively. The volume and composition of loans are similar in both
scenarios. The striking difference is that the model proposes to allocate available funds
in FX alternatives, reflecting the risk-avoiding behavior in terms of currency and
interest rate risks. It significantly decreases TL interbank funds borrowed while
tripling FX interbank. This allocation improves currency risk measure from 52 percent
in OS to 72 percent in PS. Total deposits collected decline by 13 percent in PS. Since
there is no change in total liabilities, the decrease in deposits is compensated by
borrowing other funds in addition to the similar amount of foreign funds borrowed in
OS. The profit of RTB is almost halved compared to OS.
Since 2000 is the crisis year, PS results are compared to the actual balance sheet for
two banks. The model can propose rational solutions and improve the financial well
being of the banks even during crisis. The model suggests RAB to move from a low
risk-low return position to a higher risk-higher return one by increasing the share of
government securities and short-term loans. It also proposes RTB to control currency,
credit, and maturity mismatch risks by lowering the amount of government securities,
increasing the interbank funds sold in FX and lowering the share of non-performing
loans in total loans on the asset side. These changes result in USD93 million profit in
PS compared to a loss in actual for the RTB and an improvement in profit from USD35
million to USD66 million for RAB. On the liability side, RAB’s actual and proposed
deposit allocations do not exhibit a significant divergence compared to RTB. The
model emphasizes funding by using abroad banks along with other funding
opportunities. Although RTB requires significant amount of foreign borrowing or
other sources of borrowing, this would be almost impossible during financial crisis.
This could be interpreted as the need to attract a new major shareholder so that the
JRF risk-taker bank can overcome foreign source deficiency and avoid bankruptcy. Owing
to the financial problems, RTB was taken over by Savings Deposits Insurance Fund at
6,2 the end of 2000.

Conclusion
Strong domestic financial systems play an important role in development and
148 stabilization of the overall economy. The significance of the banking sector within the
financial system becomes even more apparent in emerging markets like Turkey, which
are highly vulnerable to economic distortions and financial crisis. Structural
differences in emerging markets introduce new risks such as currency and maturity
mismatch thus the bank managers have to consider a wide range of scenarios and
manage their balance sheets optimally by developing an efficient asset-liability
management strategy. This study proposes a multi-objective decision model to reach
an optimal strategy.
GP is developed as a decision tool for ALM in order to show how different
managerial strategies affect the financial well being of banks during crisis. It is applied
to two medium scale Turkish commercial banks with different risk taking behaviors
and the results are compared under optimistic and pessimistic economic scenarios.
Although applying the model improves wellbeing of both banks, the improvement
becomes more significant as pessimistic perception of the economic environment or
risk taking propensity of the banks increases. The model is capable of developing
rational responses to strategy and scenario changes, thus can be proposed as a decision
making tool for banks operating under uncertainty. Results could be generalized
further by applying them to representatives of different bank groups as well as testing
the model under various economic and financial scenarios.

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Further reading
(The) Banks Association of Turkey (1998), Banks in Turkey, The Banks Association of Turkey,
Istanbul.
(The) Banks Association of Turkey (1999), Banks in Turkey, The Banks Association of Turkey,
Istanbul.
(The) Banks Association of Turkey (2000), Banks in Turkey, The Banks Association of Turkey,
Istanbul.