DEFINITION of Matched Book
A matched book is an approach that banks and other institutions may take to ensure that the maturities of its assets and liabilities are equally distributed. A matched book is also known as "asset/liability management" or "cash matching."
BREAKING DOWN Matched Book
A matched book is a risk management technique for banks that ensures that they have equal valued liabilities and assets with equal maturities. Essentially, a bank that adopts this approach is seeking a balance between its lending and liquidity in order to better oversee its risk.
Ways a Matched Book Is Applied
There is a functional benefit to adopting the matched book method; it lets a bank or other financial entity supervise its liquidity as well as manage interest-rate risk. Despite potential benefits, this approach is not always put to use by institutions.
Under the matched book method, an effort is made to keep assets and liabilities as closely in parity with each other as possible. That includes the amortization of assets. Matching is also done for the interest-rates for assets and liabilities. This means matching any fixed loans to fixed-rate assets, and also floating-rate loans to floating-rate assets. With floating-rate instruments, they would have to be set to coincide with the intervals for resets on interest rates.
A matched book methodology is a way of cutting down on spread risk, which is the potential for there to be a change in value between the expected price of a credit risk and the actual market price of a credit risk. This can occur with riskier bonds.
In a different context, specifically in repo transactions, a matched book can take a different approach. Under this instance, a bank may leverage reverse repurchase agreements and repurchase agreements, repos, to maintain what is called a matched book even though there might not be a balance. The bank might borrow at one rate and then lend at a higher rate so it might earn a spread and generate profits.
There can be even more examples of what is called matched book; a bank might trade repurchase agreements for the sake of covering short and long bond positions. There may also be traders who maintain a matched book to take advantage of short-term interest rate changes in relation to the supply and demand expected of underlying stock. Unlike the banks seeking to mitigate and manage risk, traders might adopt the matched book method for the sake of taking on positions that can be advantageous to them across different types of bonds and stock.