Explain how scenario analysis is used in ALM.

Explain how scenario analysis is used in ALM.

• A. It estimates only the worst-case outcomes.
• B. It uses a single interest rate scenario to guide hedging.
• C. It tests earnings, liquidity, and capital under different rate and macro scenarios to guide hedging and strategy.
• D. It is solely used for budgeting staff salaries.

Answer: (C)

Scenario analysis in ALM examines how a range of possible future rate and macroeconomic environments would affect a credit union’s balance sheet over time. It looks at how these scenarios influence earnings (net interest income), liquidity (cash flow and funding needs), and capital (ability to absorb losses and meet requirements). By comparing outcomes across different rate paths and macro conditions, management can spot vulnerabilities, evaluate how hedges and balance-sheet adjustments perform, and guide decisions about asset-liability mix, pricing, and funding strategy. This approach provides a comprehensive view of risk under varying environments, not just a single forecast or a single rate. It also clarifies that ALM decisions are about the balance sheet and risk management, not about operations like budgeting salaries.

Scenario analysis in ALM examines how a range of possible future rate and macroeconomic environments would affect a credit union’s balance sheet over time. It looks at how these scenarios influence earnings (net interest income), liquidity (cash flow and funding needs), and capital (ability to absorb losses and meet requirements). By comparing outcomes across different rate paths and macro conditions, management can spot vulnerabilities, evaluate how hedges and balance-sheet adjustments perform, and guide decisions about asset-liability mix, pricing, and funding strategy. This approach provides a comprehensive view of risk under varying environments, not just a single forecast or a single rate. It also clarifies that ALM decisions are about the balance sheet and risk management, not about operations like budgeting salaries.