In banking, asset liability management is the practice of managing risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank.
Banks face several risks such as the liquidity risk, interest rate risk, credit risk and operational risk. Asset Liability management (ALM) is a strategic management tool to manage interest rate risk and liquidity risk faced by Banks, other financial services companies and corporations.
Banks manage the risks of Asset liability mismatch by matching the assets and liabilities according to the maturity pattern or the matching the duration, by hedging and by securitization. Much of the techniques for hedging stem from the delta hedging concepts introduced in the Black-Scholes model and in the work of Robert C. Merton and Robert A. Jarrow. The early origins of asset and liability management date to the high interest rate periods of 1975-6 and the late 1970s and early 1980s in the United States. Van Deventer, Imai and Mesler (2004), chapter 2, outline this history in detail.
Modern risk management now takes place from an integrated approach to enterprise risk management that reflects the fact that interest rate risk, credit risk, market risk, and liquidity risk are all interrelated. The Jarrow-Turnbull model is an example of a risk management methodology that integrates default and random interest rates. The earliest work in this regard was done by Robert C. Merton. Increasing integrated risk management is done on a full mark to market basis rather than the accounting basis that was at the heart of the first interest rate sensivity gap and duration calculations.

In finance, and particularly banking, 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 rubles would have a significant 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 or liquidity problems.
Asset-liability mismatches can occur in several different areas. A bank could have substantial long-term assets (such as fixed rate mortgages) but short-term liabilities, such as deposits. Alternatively, a bank could have all of its liabilities as floating interest rate bonds, but assets in fixed rate instruments.
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.
Few companies or financial institutions have perfect matches between their assets and liabilities. Financial institutions in particular specialise in 'controlled' mismatches, such as between short-term deposits and somewhat longer term loans to customers.
 

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