a) Five Functions of the Asset and Liability Committee (ALCO) [15 marks]
The ALCO is a critical governance body in a bank, responsible for overseeing the balance sheet to ensure financial stability, compliance with regulatory requirements, and alignment with strategic objectives. Below are five key functions of the ALCO in a Ghanaian bank like Ecobank Ghana or GCB Bank:

1. Liquidity Risk Management
   • Explanation: ALCO ensures the bank maintains adequate liquidity to meet short-term obligations and withstand stress scenarios, as mandated by the BoG’s Liquidity Risk Management Guidelines. It monitors liquidity ratios (e.g., Liquid Assets to Total Assets) and ensures compliance with BoG’s minimum liquidity requirements.
   • Practical Example: During the 2017-2019 Ghana banking sector cleanup, ALCOs at banks like Stanbic Bank Ghana reviewed daily cash flow forecasts to avoid liquidity shortfalls similar to those that led to the collapse of UT Bank.
   • Marks Allocation: 3 marks
2. Interest Rate Risk Management
   • Explanation: ALCO manages interest rate mismatches between assets (e.g., loans) and liabilities (e.g., deposits) to minimize earnings volatility. It uses tools like gap analysis and duration analysis to assess exposure to interest rate fluctuations.
   • Practical Example: In response to BoG’s policy rate hikes in 2022 to curb inflation, ALCOs adjusted loan and deposit pricing to maintain net interest margins.
   • Marks Allocation: 3 marks
3. Capital Adequacy Oversight
   • Explanation: ALCO ensures the bank meets BoG’s Capital Requirements Directive (CRD) under Act 930, maintaining a Capital Adequacy Ratio (CAR) of at least 10% (post-2019 cleanup). It evaluates capital-raising strategies, such as issuing bonds or equity, to support growth and absorb losses.
   • Practical Example: Access Bank Ghana’s ALCO guided its recapitalization in 2018 to meet the BoG’s GHS 400 million minimum capital requirement.
   • Marks Allocation: 3 marks
4. Balance Sheet Optimization
   • Explanation: ALCO optimizes the balance sheet by balancing profitability and risk, deciding on asset allocation (e.g., loans vs. investments in government securities) and liability structures (e.g., fixed vs. variable-rate deposits).
   • Practical Example: GCB Bank’s ALCO shifted investments to higher-yield government bonds post-DDEP (2023) to improve returns while managing credit risk.
   • Marks Allocation: 3 marks
5. Compliance and Policy Formulation
   • Explanation: ALCO ensures adherence to BoG regulations (e.g., Act 930, Basel II/III principles) and develops policies for risk management, pricing, and treasury operations. It also monitors compliance with BoG’s Corporate Governance Directive 2018.
   • Practical Example: ALCOs at Fidelity Bank Ghana reviewed compliance with BoG’s Cyber and Information Security Directive 2020 to mitigate risks in digital banking operations.
   • Marks Allocation: 3 marks

b) Positive Gap and Impact of Rising Interest Rates [7.5 marks]

• Definition of Positive Gap: A positive gap occurs in gap analysis when a bank’s rate-sensitive assets (e.g., variable-rate loans, short-term investments) exceed its rate-sensitive liabilities (e.g., fixed-rate deposits, borrowings) within a specific time horizon. This means the bank has more assets that reprice faster than its liabilities.
  • Explanation: In gap analysis, the gap is calculated as Rate-Sensitive Assets (RSA) minus Rate-Sensitive Liabilities (RSL). A positive gap (RSA > RSL) indicates the bank’s net interest income (NII) is sensitive to interest rate changes.
  • Practical Example: If Ecobank Ghana has GHS 500 million in variable-rate loans (RSA) and GHS 300 million in fixed-rate deposits (RSL) maturing in one year, the positive gap is GHS 200 million.
• Impact of Rising Interest Rates: When interest rates rise, a positive gap benefits the bank because the yield on rate-sensitive assets increases faster than the cost of rate-sensitive liabilities. This leads to an increase in NII, enhancing profitability.
  • Example: In 2022, when BoG raised the policy rate from 14.5% to 22%, banks with positive gaps (e.g., Stanbic Bank Ghana) saw higher interest income from repriced loans, while fixed-rate deposit costs remained stable.
  • Risk Consideration: However, if rates rise too sharply, it may increase borrowing costs for clients, potentially leading to higher default risks, as seen during Ghana’s high inflation period in 2022-2023.
  • Marks Allocation: Definition (3 marks), Impact (4.5 marks)

c) Interest Rate Swaps and Buyer Expectations [7.5 marks]

• Explanation of Interest Rate Swaps: An interest rate swap is a derivative contract where two parties exchange interest payment streams, typically swapping fixed-rate payments for floating-rate payments (or vice versa), based on a notional principal. It is used to manage interest rate risk under standard terms like ISDA (International Swaps and Derivatives Association).
  • Practical Example: A bank like GCB Bank might enter a swap to convert fixed-rate loan payments to floating-rate payments to match its floating-rate deposit liabilities, reducing interest rate mismatch.
• Expectations of a Buyer: The buyer of an interest rate swap (e.g., a bank or corporate client) expects to hedge against adverse interest rate movements:
  • Fixed-to-Floating Swap Buyer: A buyer paying a fixed rate and receiving a floating rate expects interest rates to rise, so the floating-rate payments they receive increase, offsetting higher costs elsewhere.
  • Floating-to-Fixed Swap Buyer: A buyer paying a floating rate and receiving a fixed rate expects rates to fall, locking in a predictable fixed cost to avoid rising liabilities.
  • Practical Example: In 2023, post-DDEP, a Ghanaian corporate client with a variable-rate loan from Zenith Bank Ghana might buy a floating-to-fixed swap, expecting BoG’s policy rate to stabilize, to ensure predictable debt servicing costs.
  • Marks Allocation: Explanation (3 marks), Expectations (4.5 marks)