Psychospritual Aspect in Financial Planning

Displaying the Psycho-spiritual Aspect of Personal Financial Planning: A Suggestion on Key Factors Indicating Prosperity in Qualitative Valuation

Jeffry Merril Liando (2002)

1. Introduction: Psycho-spiritual Aspect as Key Result Area

The psycho-spiritual aspect of personal financial planning inevitable takes place as clients deeply rely on and expect too much of their financial planner’s care. This is fairly seen as the impact of financial planner’s effort to build a strong and ongoing relationship. In this essay, a psycho-spiritual aspect is defined as a view in searching a client’s psycho-spiritual issues relating to valuation of a client’s ongoing peace of mind. Ongoing peace of mind is a remarkable main outcome of the financial planning relationship,[1] therefore this can be taken as a goal in a key result area (KRA) of psycho-spiritual aspect (PSA) for a personal financial planning (PFP) enterprise.[2]

The goal of maintaining client’s ongoing peace of mind in the KRA of PSA can be stated in objectives on which each of them is specified, measurable and possible to result an appropriate outcome in a period of time.[3] All of the outcomes are simultaneously used to achieve the goal. This essay is directed to discuss the concept, method and process of setting the objectives, appraising the PSA based on the money consciousness concept through a method of defining the key factors of prosperity and a process of qualitative valuation in the framework of the PFP process. The objectives are specified by defining the key factors of safer, happier, richer and benevolent, measurable on the critical values decided on a client’s concerns, and possible to achieve with a planner’s recommendations with respect of the financial ratios as the outcomes. All the outcomes are used to prejudge a client’s PSA condition whether prosperous (ongoing peace of mind) or scarce condition in the process of qualitative valuation. If in realisation of planning the valuation indicates prosperous condition, then financial planners achieve the goal of a client’s ongoing peace of mind and a client is recommended to follow a stewardship program.

Financial planners realise their limits in covering the psycho-spiritual aspect although they work closely with a client’s dreams, emotions and hardships.[4] This also regards the rule of competence that ensuring the member of the Financial Planners and Insurance Advisers Association Incorporated (FPIA) in New Zealand to perform services on a competent, efficient and business-like manner and only advise in those areas in which the member has competence.[5] Therefore, in order to display the PSA as a justified strategic form, it is necessary to simulate the whole strategic in the framework of the personal financial planning process. This can be seen in appendix 1, which only describes the goals of each KRA and its objectives concerning the code of ethics and professional conduct of the FPIA Association Incorporated, New Zealand.

2. Money Consciousness as Basic Concept

The basic concept used to interpret the psycho-spiritual aspect is that the money consciousness. A money consciousness is how a person feels, think, and believe about money. This consists of a prosperity consciousness (PC) and a scarcity consciousness (SC). People with a PC know that there is a limitless supply as they will receive and can generate their share more. On the other hand, people with a SC never have enough and are afraid of losing whatever they own. In other words, the PC indicates certainty in finances whereas the PC indicates uncertainty.[6]

Inconsistency in a Client’s Judgement

However, a view in the framework of capitalism-individualism suggests that there are always factors of competitiveness, unequal power and upgrading capacity in people’s mind, which may influence them to wonder whether there is a certain profitably limitless supply of money every time or not.[7] People can have their own judgement based on their record, current status and achievement. Thus, it is possible that one who actually has a PC will feel, think and believe having a SC anyway, or vice versa. Here, the role of financial planners can be to give them appropriate advice using reasonable and prudent judgement based on the fact of diagnosis, which honestly showing their financial condition. Planners then direct them to accept upgraded or downgraded objectives in the recommendation, which financially showing genuineness.

For example, a client feels have failed to upgrade his car $10,000 to a $30,000 car after five years and fears that his colleagues may underestimate him (a SC). By showing his record, he can be judged success (a PC) when brought both his wife and daughter together to Europe attending his son graduation two years ago as he spent $9,000, three times bigger from the budget. Then, he may be recommended to make a new plan to upgrade his car for $20,000 and buying his daughter a $10,000 car for the next five years and encouraged to be proud of his achievement on his son’s education. Another example, five years later he feels success to upgrade for $50,000 car and buy a $10,000 for his daughter and do not fear anything (a PC). By showing his current status, he can be judged failed to control his daughter expenditures costing $10,000 in the current month. As a result, the amount overdraft and credit card is notified over than 30% of call deposits as planned and there will be significant interest loss of 5%.

Money as Energy

From a holistic point of view, money is thought often of as energy that is not a thing to be possessed but an action to transact, transfer and exchange.[8] The psycho-spiritual view of this concept is how human being uses money for purpose and finds satisfaction by not looking at the amount but through assessing the positive things affected when achieving, aligning and balancing the goals. For example, for the same amount of personal income, it can be derived whether from an independent income from salary or a dependent income from income support. Paying for purchases can be considered whether on cash or by credit card. Loans to family member can be decided eventually as a gift. Moreover, there are choices when allocating funds whether for buying lifestyle assets, holiday, travel, saving/investment or charity.

3. Defining the Key Factors of Psycho-spiritual Aspect in Financial Planning

In order to apply the PSA in PFP, using the interpretation of money consciousness and money as energy, financial planner can judge a client’s psycho-spiritual conditions whether prosperous or scarce, using qualitative valuation. Although both conditions can be known based on a client’s judgement, several general factors need to be defined by financial planners when carrying out the PSA in the PFP services. Defining the factors that are significant in judging both conditions, financial planners can then ask a client to determine his or her tolerance in numbers for particular factors. For example, one of particular factor of a prosperous condition is to have appropriate overdraft or credit card facilities. After asked, a client determined that his secured bank overdraft and credit card facilities has to be up to 30% of call deposit account with interest loss level up to 1%.

Money Capacity

Hence, the factors to view psycho-spiritual conditions will be discussed in regard with the rationale of money capacity. Money capacity can be suggested as one’s ability in both action and amount to transact, transfer and exchange in and over lifetime. Relating to the personal financial planning process, a full capacity of money may include all items of balance sheet, income statement, budgeting, portfolio management, risk management, retirement planning and estate planning. For the purpose of defining factors of PSA in the framework PFP, a full capacity consists of a given capacity, a psycho-spiritual capacity, and a disregarded or irrelevant capacity.

Basic Assumption of Given Capacity

As basic assumption, a given capacity of money means a client’s ability to handle all basic expenses, mortgage, all items in risk management and taxations using current account funded by his regularly permanent personal income. This also means a capacity that has to be existed, sustained and stable, therefore as given factors these do not have any effect to the peacefulness and the fearfulness in a client’s mind in financial planning. Every people must cope all their basic living expenses, have and repay the mortgage for housing, cover all the risks they have, such as emergency fund, income protection, security of the home, provision in the event of debt and health cover. It is important to note that covering risk by providing emergency fund relates to maintaining unused capacity of bank overdraft and credit card along with accumulating fund in call deposit account.[9]

The Key Factors Indicating Prosperity from Psycho-spiritual Capacity

A psycho-spiritual capacity can be then defined as a client’s ability to provide money for the purpose of: (1) repaying bank overdraft and credit card without any significant interest loss, being safe as showing accountability to creditors, (2) financing lifestyle assets expenditures and travel and holiday expenses, being happier as realising dreams and enjoying life, (3) rising net worth, being richer as sustaining growth, and (4) giving a portion for charitable funds (or other types of donation), being benevolent as shares grace to others. These four factors, in my opinion, are then the most suitable and reasonable factors to view and judge a psycho-spiritual condition whether prosperous or scarce.

Irrelevant Capacity in Displaying the Psycho-spiritual Aspect

A disregarded or irrelevant capacity, which can be disregarded and is not relevant to concern only when examining a client’s current psycho-spiritual condition, is ability to finance financial assets gaining appropriate returns (as in portfolio management) and to provide appropriate funds or net worth for retirement planning and estate planning. Portfolio management seems like more technical-analytical aspect, moreover this factor is likely refers to examining a financial planner’s competence in advising a client’s portfolio decisions. Retirement planning cannot be chosen as a PSA factor because it depends on how great a client generates net worth before retired. Being prosperous at retirement depends on being prosperous when still productive. Estate planning has been covered by the term of life insurance in the given capacity of risk management.

In conclusion, taking the four factors defined in the psycho-spiritual capacity as the required conditions, a prosperous condition can be judged as a condition on which a client is safe, happier, richer and benevolent. On the other hand, a scarce condition can be judged a client is not having all of the criterions together. The critical values of the factors or criterions are therefore decided based on a client’s concern, worry or desire. However, to portray the PSA in the PFP process using the defined factors above, qualitative valuation is need to employed.

5. Qualitative Valuation in Portraying the Psycho-spiritual Aspect

Financial planning is an art therefore should not be identical between the clients and covers unique requirements and circumstances (the psycho-spiritual aspect) as much as possible to gain from the services provided applying a “modular” planning. Ongoing peace of mind should not be ignored as a main outcome of the financial panning relationship. The key factors determining the successful outcome “are highly dependent upon the planner’s ability to establish empathy and trust with the client and to build a strong and ongoing relationship.”[10] Therefore, a client’s ongoing peace of mind about money can be used as a measure of achievements in establishing empathy and trust along with building a strong and ongoing relationship. However, a client’s current financial condition as caused by his decisions is viewed quantitatively whereas on going peace of mind about money is a qualitative measure.

Overall Process of Qualitative Valuation

The technique of portraying the PSA in the PFP process uses qualitative valuation. At the stage of establishing goals and objectives in the PFP process, qualitative valuation starts through offering a client the four PSA factors as qualitative criterions, i.e. safer, happier, richer and benevolent, and then determining the critical values of each factor using financial ratios. Then, it continues to qualitative assessment, which is carried out mainly at the stage of regular review and monitoring for the purpose of PSA analysis. Quality assessment consists of two steps, first, through financial ratios analysis detecting each factor of qualitative criterions regarding its critical values and concluding a client’s condition as a planner’s prejudgement. Second, through interview observing each factor of qualitative criterions regarding its attitude scales and finding out a client’s judgement of PSA condition. Third, based on early warning signal system, determining the level of critical values of the PSA factors to predict a prosperous condition in the future.

Financial Ratios Representing Key Factors

At the first step of quality assessment, financial ratio analysis is used to evaluate the four PSA factors focusing on bank overdraft and credit card balance, expenses for lifestyle assets, travel and holiday, net worth balance and disbursement in charity donation. This will refer to both cash flow and balance sheet items shown in a client’s financial report and several financial ratios used in financial modelling and analysis.

The first factor is to ensure that a client is able to repay and gain both bank overdraft and credit card without any significant interest loss. This can be interpreted by comparing the total amount of bank overdraft and credit card account to the total amount of call deposits. Moreover, any significant interest loss can be interpreted by comparing the total accrued interest fees payment of bank overdraft and credit card to the total accrued interest incomes receipt of call deposits.

Here, client is asked to determine concerned percentages for both ratios. Client is recommended to avoid using overdraft and credit card to cover all basic living expenses (incl. foods, clothing, accommodation and transportation), mortgage repayment, insurance expenses (incl. health, income, life and house insurance), and taxes. Besides that, client is expected to have willingness to keep an appropriate amount for saving and call deposit accounts along with keeping an unused capacity for overdraft and credit card facilities in the current account. However, this is done after covering other expenses, such as investment cost (on planner’s advice), entertainment expenses and lifestyle assets.

The second factor of condition is to ensure that a client is able to finance lifestyle assets purchase and pay for other expenses (including dinner-out, shopping, holiday, entertainment and overseas travel). The ratio for this is the comparison between actual and budgeted of other expenses plus life style assets expenditure. Here, a client is asked to determine concerned percentages for the actual-budget variance and committed to spend expenses more than or at least equal to those he has planned or dreamed.

The third factor of condition is to accelerate the net worth every time. This can be interpreted by calculating the growth of the net worth every time. Here, a client is asked to determine a desired growth every time. A client has to understand that the growth cannot go down at least it has to be maintained at same level.

The fourth factor of condition is to ensure that a client as a success human being has given a portion of his income by sharing grace in charity or any other donations to others or society. The ratios are suggested as follow, total charity and other donation to total interest income and total church donation and gifts to personal income. This seems like idealistic because a client is unlikely to mention how much they have spent for those. Therefore, this factor can be assessed only with a client’s honest himself.

From diagnosing of these four factors, a financial planner would be able to analyse a client’s PSA condition, as a prejudgement, whether a client is in prosperous or in scarce. A client can be said in prosperous condition if all of the conditions are achieved, whereas a scarce condition is judged if any of those are not achieved.

However, the prejudgement at the first step of valuation may be inconsistent with a judgement, which a client really feels, thinks and believes. This regards the limits of financial planners in applying PSA in PFP. As the ongoing peace of mind can be considered as an expected outcome the financial planning relationship, a prosperous condition should reasonably and prudently be portrayed by a financial planner. Therefore, a planner has to conduct an interview, at the second step of valuation, diagnosing the factors of PSA and analysing qualitative conditions to find a client’s judgement. This can be done through questioner with attitude scaling basis.

As the process occurs during the time of planning relationship, qualitative valuation can continue to the third step, that is an early warning signal system. Using statistical probability methods, a prediction model of a client’s condition in the future is judged by scoring the multiple regression function of the PSA factors. By putting current ratios of PSA factors into the function, the probability of prosperous condition then can be predicted. However, this method is not discussed further in this essay.

Stewardship and Coaching

After undergoing the qualitative valuation of PSA analysis, financial planners will know a client’s condition whether prosperous or scarce condition. If a client’s condition is prosperous, this means that a client has the ongoing peace of mind and thus the planner gets achievement in providing PFP services to him. However, there is a follow-up service relating to whatever the condition is. For prosperous condition, the follow-up service can be a stewardship, and for scarce condition, the follow-up service can be a coaching.

The concept of stewardship is explained as: “implications for the handling of money are especially evident in twentieth-century understanding of stewardship. These implications include exercising fiscal responsibility in the budgeting and spending of one’s money, giving a portion to charitable causes and restraining one’s expenditures on unnecessary consumer goods. Stewardship thus has implications for the normative restraint of economic life.”[11] In the framework of financial planning, this can be interpreted as the fourth factor of PSA discussed above. Here, the role of financial planner is to take responsibility in allocating the surplus of a client’s net worth to charity, other donation, church donation or gifts. Financial planner has capacity to connect a non-profit organization, such as charity foundation, church, mosque or local social organization either on a client’s order or as offered as financial planner’s initiatives. For a qualified client, there would be a yearly program of “public award of successful human being” given by coordinating the event with public media services.

Coaching as a tool of carrying out the PSA in PFP is defined by the International Coaching Association: ”Professional coaching is an ongoing partnership that helps clients produce fulfilling results in their personal and professional lives. Through the process of coaching, clients deepen their learning, improve their performance and enhance their quality of life.”[12] This technique is useful for a client with a scarcity condition as financial planner has capacity to develop a client’s psycho-spiritual condition relating to personal life, work, business and social relationship. For example, introduce a client to personal development program, seminar or prosperity website, or conduct a meeting between clients for the purpose of digging the story one’s success to be shared to others.

7. Conclusion

In conclusion, displaying the psycho-spiritual aspect of financial planning is quite hard and complicated to put into practice. Financial planners may offer this technique as ensuring the financial planning outcome of a client’s peace of mind. However, there is a cost for a client as he or she is helped to understand financially his or her prosperity condition regarding the four key factors as the indicators. Meanwhile, financial planners initially state to take full responsibility in the risk management and portfolio management they offer in the services.


[1] Ed Vos: 2001, p. 42.

[2] The ongoing peace of mind is becoming more important after achieving the material goals the needs to include a comprehensive goal that concluding the psycho-spiritual views of a client’s condition. In conducting a personal financial planning business, the goal of ongoing peace of mind can be put as one of the key strategic factors.

[3] Hunger, J. David: 1996, p. 11. As the goal is too broad, this can be narrowed into the statement of objective in achieving the ongoing peace of mind of client. However, with such accounting financial ratio analysis, this can be quantitatively measured.

[4] Maureen EP Irish, Journal of Financial Planner, April 1999.

[5] Rule 2: Competence, Code of Ethics and Professional Conduct of the FPIA, New Zealand.

[6] As suggested by Joan Sotkin in her article about the framework of holistic approach to financial planning in Prosperity Place.Com, May 2, 2001.

[7] This regards the concept of inequality in the framework of capitalism-individualism explained by Goetz Kluge in Poorcity.Richcity.Org. http://poorcity.richcity.org/entdiff.htm

“ In a system consisting only of unintelligent wealth (E) and intelligent people (A), looking at redestribution in terms of osmosis helps to distinguish between two extreme (as such non-existing) cases and to create a third case:

    1. Merit: If unintelligent wealth cannot move and intelligent people are mobile, distribution determined by people is the result.
    2. Luck: If unintelligent wealth is mobile and intelligent people cannot move, arbitrary distribution to people is the result.
    3. Luck and Merit: If unintelligent wealth as well as intelligent people are mobile, arbitrary distribution and determinable distribution coexist. This is reality.

Capitalism, individualism: For this equivalent society, wealth is a "territory" for which individuals compete by merit. Pure capitalism, a free market and pure individualism are the reference ideologies for this system. In order to describe the extreme side of capitalism we use its socialist caricature: no emphaty between individuals; permanent and "hot" fight between individuals; winner takes all (unfair distribution of all wealth: a part of all individuals own everything); personal advantage only is dominant incentive; trade is war.”

[8] As suggested by Ronnie Kahn in Journal of Financial Planning, Feb, 2001.

[9] Ed Vos, 2001, p. 48.

[10] Ed Vos: 2001, p. 41-42 and p. 60.

[11] Robert Wuthnow, Religion and Economic Life, in “The Handbook of Economic Sociology”, 1994, p. 363.

[12] As suggested by Mell McDonnell in Journal of Financial Planning, October 2000.

Bibliography

Ed Vos, Personal Financial Planning for New Zealanders, 2nd ed. 2001, Dunmore Press Limited, Palmerston North, New Zealand.

Goez Kluge, Wealth and People: Inequality Measures, What's the difference? © Munich, 1999/03/28. http://poorcity.richcity.org/entdiff.htm

J. David Hunger and Thomas L. Wheelen, Strategic Management, 5th ed. 1996, Addison-Wesley Publishing Company, Inc, USA.

Joan Sotkin’s, Money. 2000, Prosperity Place, Santa Fe, USA. http://www.prosperityplace.com/excerpts/money.html.

Robert Wuthnow, Religion and Economic Life. In “The Handbook of Economic Sociology”, Neil J. Smelser and Richard Sedberg, editors. 1994, Princeton University Press, New York, USA.

The Code of Ethics and Professional Conduct. 2000, Financial Planners and Insurance Advisers Association Incorporated, New Zealand. http://www.fpia.org.nz.

Journal of Financial Planning:

Catherine Newton, Letting Go: When Planners and Clients Part Ways. Journal of Financial Planning, October 2000 ed. 2001, Financial Planning Association, Denver, USA. http://www.journalfp.net/psychology.cfm.

Maureen E.P. Irish, Psychology and sipirituality: How deep do planners want to go? Journal of Financial Planning, Denver, April 1999. Lecture file.

Mell Mc Donnell, Getting to Know You. Journal of Financial Planning, October 2000 ed. 2001, Financial Planning Association, Denver, USA. http://www.journalfp.net/psychology.cfm.

Ronnie Kahn, Money Consciousness: A Psychospiritual View of Financial Planning. Journal of Financial Planning, February 2001 ed. 2001, Financial Planning Association, Denver, USA. http://www.journalfp.net/psychology.cfm.

APPENDIX 2

copyright by Jeff Liando Psycho-spiritual Financial Planning

The risks of risk management: in the framework of Asset-Liability Management

The risks of risk management:

in the framework of Asset-Liability Management

Jeffry Merril Liando (2007)

After thirty years of development in Asset-Liability Management (ALM), history has noticed danger rather than reward of it. Started with a simple way of gap management to match gaps between interest sensitive assets and liabilities and between market value of assets and liabilities, it developed to duration model until eventually taking into account the advent of derivatives activities and asset securitisation within the framework of ALM. The latter development seems to be the current issue that puts the implementation of ALM in jeopardy.

Financial institutions have noticeably been the main users of ALM but then corporations have seen the benefit of using it and all unfortunately become the abusers of it. The ALM technique has been interpreted as the way to reshape their balance sheet even by involving separate entities' balance sheet, in this case, using a special vehicle enterprise (SPE). With a fine goal of mitigating risks of interest rate, exchange rate, credit and liquidity, the use of financial risk management in the framework of ALM often comes to a failure. Financial institutions and corporations may potentially face big losses in marked-to-market portfolio value, interest rate and exchange rate, leading to a liquidity problem and insolvency, even the worst case of bankruptcy.

Every time a new context is implemented in ALM, a newer risk issue may arise particularly when synchronising with the other contexts of financial risk. Firstly, repricing gap model may create market value risk and maturity gap model may result to arising of interest rate risk from different cash flow timing. Secondly, potential errors in modelling duration may arise considering factors of embedded options in prepayment risk and liquidity risk and different term structures for different periods. Thirdly, derivatives activities for rebalancing portfolio in duration model may lead to derivatives risk. Fourthly, potential risk of ALM may arise when shifting the goal of derivatives instruments from hedging to speculative profit taking. Fifthly, some ALM tricks with securitisation innovation may lead to securitisation risk.

This essay tries to divide the implementation of ALM in different contexts in accordance with its development to identify the risks of financial risk management. Ideally by the phrase, risk management will not produce risks but eliminate them, however, the tendency of failures and the severity and frequency of losses may be enough to justify the risks of practicing financial risk management. In the sequence of development in ALM, it may come up with a series of risks, as follows: interest rate and market value risks, rate modelling risk, derivatives risk, speculation risk and asset securitisation risk. However, one relevant context is reserved for other discussion outside this essay, that is, credit derivatives risk which is related to derivatives and securitisation risk. This essay particularly addresses how such risks may be produced in the implementation of ALM by presenting several cases of failures in financial risk management, and begins with some contextual frameworks of ALM's concerns and the development of its model in managing liquidity and minimising financial risks.

Nevertheless, the potential failures in ALM can be early identified with a preventive action by the supervisors to monitor the fair value of financial assets and derivatives instruments, the current exposures of interest rate risk and market risk and the net positions of foreign currency. This has been implemented in New Zealand within the environment of financial institutions before the Basel-2 Accord. Moreover, a responsive action to prevent a higher magnitude of losses can be done with such a technical way in the marketplace by manipulating the trading system, as the NYSE and CME use a system called the circuit breakers. This essay would conclude that the preventive and responsive action may early identify the potential risks and assist the abusers to cope with their failures.

ALM in financial institutions and corporations

By a very basic definition, ALM in banking context can be defined as a coordinated management of a bank's balance sheet or portfolio focuses on planning, directing and controlling the levels, changes and mixes of the various on- and off balance sheet accounts which generates the bank's income-expense statement. ALM is approached in three stages: general balance sheet structure, specific balance sheet items and then income-loss production based on policies in spread management, loan quality, generating fee based income, control of non-interest income, tax management and hedging practices.[1] The key point in ALM is management of interest rate risk as the main sources of banks' revenues and expenses.

At the early stage of development, the main goal of ALM is to reduce liquidity risks as the greatest concern in financial institution management by calculating the net of cash flows in different maturity profiles. Then with repricing gap model, interest rate risk is taken into account by calculating the gap between interest sensitive assets and liabilities. Next, ALM considers market value with maturity model by calculating the maturity gap between the weighted-average maturity of assets and liabilities.[2] At this stage, ALM is also known as a gap management.

The next development is to consider cash flow factor in relation to interest rate that is not thought about in gap management, as the interest rate risk is not eliminated completely. ALM method then takes into account duration of assets and liabilities by calculating the average life of the present value of the cash flows. The goal is to match the duration gap as then ALM method came up with the idea of hedging interest rate.[3]

The implementation of ALM at this stage is believed as a way of hedging balance sheet position against the future movement of interest and exchange rates. Hedging position is commonly produced by entering derivatives contracts such as futures, forwards, options and swaps, or by trading derivatives securities such as liquid yield option note, treasury strips, callable and putable bonds and warrants. Here immunisation term is used and related to portfolio rebalancing. Finally, later development in asset securitisation introduced new types of derivatives contracts and securities such as ABSs, MBSs, CDOs, IOs/POs, and credit derivatives such as CDSs, CLNs, TRSs and Synthetic CDOs. These derivatives can cover credit risks directly in the framework of ALM.

As a comprehensive function, ALM synchronises its roles between liquidity management and financial risk management for managing interest rate and exchange rate within a financial institution. In a short-term time frame, it may refer to liquidity management as trading securities to provide sufficient funds for short-term liquidity without any significant losses. In order to meet liquidity requirement, ALM involves with daily transactions in securities trading in the form of short-term money market securities, such as government securities, central bank bills, bank bills, repos and commercial papers. Yet, ALM should be more concerned on managing interest rate and exchange rate risks with hedging positions than taking speculative positions.

Popular liquidity-profitability dilemma and risk-return trade-off have shifted ALM goal from liquidity management to the intention of necessarily taking profit as it is possible.[4] Opportunities created from the price volatility of securities prices can be grabbed for profits by conducting such an active portfolio management. This has also been related to asset securitisation as to consider the benefits of it in managing liquidity and profitability at the same time by generating inflows from portfolio transfer, originator rate spread and service fee. Furthermore, trading derivatives for managing financial risks has blurred the original ALM goal to profit orientation by betting on the economic environment that may be addressed as the potential source of problems in financial risk management.

Seeing the sophistication and usefulness in financial institutions, ALM has been a sought-after tool for corporations and the term is more commonly known as financial risk management. The reason is that ALM framework in the context of corporations still deals with similar risks in their balance sheet structure. In asset side, a corporate has inventory, financial assets and receivables that need to be hedged for the uncertainty of future exposure of interest rate, exchange rate and commodity price, whereas in liability side, there are some financial risks in bonds and loans to be managed. In practice, financial risk management is part of a treasury management of a corporate and deal largely in fixed income securities trading and derivatives activities in order to manage financial risks including interest rate risk, foreign exchange risk and also commodity risk.

Interest rate risk and market value risk

Banks can review their liquidity positions with repricing gap model by remarking the net gap position for maturity less than one year. A negative gap signs a low liquidity position and a positive gap indicates a high liquidity position. A dominant position taken by most banks is normally negative gap for short term as they are funded by shorter maturity liabilities and invest in longer maturity assets, or known as a short-funded position. The basic strategy is that banks usually believe in an upward yield slope of term structure where the short term interest rate is lower than the long term one, thus the interest cost from the shorter maturity liabilities is lower than the interest income from the longer maturity assets.

However, the potential risk arises when the short term interest rate starts to rise and approaching the long term interest rate level as the term structure may shape downward. Here banks need to sell some of the long maturity assets in order to keep the profitability level. In this case, fixed income securities are of course the assets that can be sold immediately to offset the repricing gap for a short term time frame, from a negative gap to a positive gap, and then adding the liquid asset portfolio with more short maturity securities.

For example, a bank considers taking a short-funded position in the short run by keeping a larger proportion in long maturity bonds. If the interest rate is believed to increase in the future, the bank should increase the gap by reducing the proportion of long maturity bonds and adding the proportion of short maturity securities such as Bank Bills, thus the net interest margin does not drop dramatically or otherwise improves. In contrast, if the interest rate is believed to decrease in the future, the bank should do nothing and takes more advantage from the broadening gap as gaining maximum net interest margin.

No one knows the movement of the future interest and some banks believe that the interest rate continues to decrease and keep the larger proportion in long maturity bonds. When the interest rate increases and the long dated bonds are not hedged with derivatives contracts, bonds futures for instance, such banks would get loss, particularly after being sold or marked-to-market. This is as what happened with the National Bank in 1993 and 1994.[5]

In 1993 the National Bank invested around $823 million of government and local authority stock and enjoyed the decreasing interest rate from around 7.5% to around 5.5% during that year. It had marked its book to market and the end of 1993 with $6 million for investment and $817 million for dealing and continues to bet on further decrease in interest rate. Unfortunately the interest rate had been increasing during 1994 and at the end of the year the National Bank was still being in long dated position. Consequently, the value of the $817 million had dropped to $364 million.

Duration model and modelling risk

The series of cash flows until maturity in the portfolio of assets and liabilities imposes the implicit time in each cash flow, which is not considered in the gap model. If an asset with half-yearly time steps matures in two years, it can be said to have a maturity of two years. However, the present value of cash flow in each period corresponds with the implicit time in the episode of every half-yearly time step, for example, the present value at period 2 has one year life and that at period 3 has 1.5 years life. Thus, the average life considering the implicit time episodes can be calculated and is know as duration, which should be less than 2 years of maturity. Financial institutions then can model interest rate risk in the framework of ALM by calculating the duration gap between the weighted-average asset portfolio and liability portfolio and matching the duration gap, or the leverage adjusted duration gap after considering the market value of net worth, to zero. From this stage of development in ALM, duration model has been widely used by banks.

The effectiveness of duration model depends on the effectiveness in modelling it in the framework of ALM. In modelling duration approach, a simulation technique is normally used by the treasury management or Asset-liability Committee (ALCO) of a bank by employing a sophisticated tool of computerised data processing software. The data input includes the individual volume, mix and interest rate of the current position in assets portfolio and liabilities portfolio. The assumptions and parameters used may include the forecasting of future volume, mix and interest rate in different scenarios. The output is to make a projection of future income and to see the effect of interest changes on duration gap. The result of the analysis is expected to base some decisions in taking specific hedging strategy for managing interest rate risk with derivatives activities.

It seems potential errors in modelling duration arises when using assumptions for future volume, mix and interest rate in different scenarios. The factors need to reconsider are the embedded options risk of borrowers and depositors[6] and different types of term structures[7]. The embedded options factor suggests that borrowers would prepay their loans once interest rate decreases and depositors would withdraw their deposits once interest rate increases. Here the volume and mix of asset and liability portfolios may change. The term structure factor suggests that a flat yield curve assumed in duration model does not happen all the time, thus interest sensitivity scenario may change as the interest rate for each maturity moves divergently.

Instead the general factors, Blue and Hedberg (2001)[8] suggest three specific ALM modelling errors, as follows, (1) inaccurate current position, (2) inadequate non-maturity deposit behaviour, and (3) switch option. Inaccurate current position means that a financial institution may incorrectly state pricing information for interest rates of the current position of assets and liabilities that would lead to a miscalculation of net interest income and present value. Inadequate non-maturity deposit behaviour is an error made when a financial institution inputs repricing behaviours and average lives in the absence of contractual data to confirm these estimates which may impact both interest expenses and present values for core deposits, leading to a mistake in the value-at-risk IRR calculations. Switch option is an error in switching the cash flow of option inputted according to the tendency of interest rate movement. The common source of these errors as suggested further, as follows, (1) inaccurate assumptions for option-related risk (ORR), (2) inaccurate credit spreads to treasury securities, and (3) inaccurate points on the treasury curve that calculate resulting average lives, effective durations, cash flow projections, yields, and prices.

Derivatives risk

The result of analysis in the duration model, regardless the potential error risk, is expected to base some decisions in managing interest rate risk with derivatives activities. Direct duration matching with derivatives contracts or securities has been commonly used for producing some hedging positions. However, this may cost much and face a larger risk of losses as derivatives may expose a bigger probability and severity of default than the underlying assets may do.

Futures and swaps are commonly used for hedging interest rate in duration matching and immunisation strategy. With futures, the interest rate movement on the balance sheet can be offset by the price movement of the futures. Increasing interest means decreasing futures price and vice versa, then the loss of net worth on the balance sheet where the asset duration is bigger than the liability duration can be offset with the profit of short selling futures. With swaps, the duration portfolio which is the weighted average of the durations of the assets and the liabilities can be modified with the swap duration which is the difference between the fixed rate duration and the floating rate duration. To increase the portfolio duration, the swaps contract needs to be entered by receiving fixed rate and paying floating rate.

Despite of the usefulness of derivatives activities in risk management, there are some potential risks that should be considered, as Sinkey (2002) interestingly described those risks as IS MORC ILL?[9] This stands for Interaction (covariance), Systemic, Market, Operational, Regulatory, Credit, Intellectual, Liquidty and Legal. The systemic risk focuses on the collapse of the financial system, market risk on price behaviour, operational risk on human and system error, regulatory risk on restrictions, credit risk on the default of counterparty, intellectual risk on inability to understand the instrument, liquidity risk on the inability to buy or sell particular contracts and legal risk on contract documentation, authority and bankruptcy.

The example of interaction (covariance) risk is the case of Long Term Capital Management (LTMC) in 1998 where LTMC bets on government bonds and corporate stocks that the position offset with each other in the portfolio.[10] It held positions in US, European and Japanese government bonds and S&P stocks options without hedged position. When the Russian bonds defaulted followed by high selling of European and Japanese bonds, the demand came to US bonds and then the Treasury yield soared. LTMC finally lost 40% in its value as a result of a divergent movement between its assets in the portfolio.

One case related to futures contract in New Zealand is as follows. In 1990 Westpac lost up to $30 million as guaranteeing Jordan Sandman Futures for trading five-year government stock futures as Stephen Francis, a London-based Kiwi, exposed Westpac and Jordan Sandman Futures to a $1.9 billion risk. As a result, Westpac and JSF found themselves staring at huge short positions in five-year government stock futures when the yield was decreasing. Cases occurred overseas are as follows: in 1994 Procter & Gamble lost $US157 million on leveraged interest rate swaps for US dollars and Deutsche marks written through Bankers Trust on the assumption that U.S. and German interest rates would continue to fall. Cases related to commodity futures by corporations are as follows: Codelco Chile lost $US200 million in 1993 on futures trading of gold, silver and copper and Metallgesellschaft AG German lost $US1.5 billion on oil futures in the same year; in 1996 Sumitomo Corporation lost a very huge amount of $2.8 billion in copper futures trading. Also, in 1994 Orange County California lost $US1.6 billion on a structured notes trading. It seems most derivatives failures occurred in the mid 90s after 15 years invented.[11]

Instead of managing interest rate risk, derivatives risk also arises in managing exchange rate risk. Some instruments used are currency swaps, currency options and currency futures. The impact of the currency derivatives failures may even be worse. This is due to the characteristic of the foreign exchange market as a huge on-line global market connected all over the world in which the magnitude of market supply-demand is impossible for the players to observe. The market is 24 hours and the price volatiles every second. In case of market shock, a financial institution can lose very big money in just a few seconds. The most common mistake a financial institution, or precisely a person, may possibly make is that when she takes a position in a wrong direction against the market for such a long time hoping that the price would come back, which is in fact never coming back.

For example, in the first dealing quote NZD 1 is traded at USD 0.40 (sell) - 0.50 (buy). As expecting the price would go up a trader buys NZD10 at USD 0.50. The price then keeps fluctuating but decreases to 0.35/45 until the second quote. Instead of hedging the position with short selling, she buys again at 0.45 as expecting that the price would start to increase from this level. Using a martingale tricks with a double-cover hedge, she doubles the bet to NZD20 expecting now is the time to offset the previous open position and believes the price to rise. Unfortunately, the price still decreases. At the third quote, the price given by the dealers is 0.30/40 and she is out of deal as waiting the price to go up. At the fourth dealing quote, the price given is 0.35/0.45 and finally decides to lock the position at 0.35 by short selling NZD30. She locks NZD3 loss at 0.50 and NZD2 loss at 0.45 and the price is going down from her open position for months and pays additional fees of transaction and interest.

Prediction of exchange rate movement is hard to model so that the tendency of success in derivatives trading may usually be based on technical analysis although fundamental analysis also contributes to the prediction. Therefore, losses in currency derivatives trading are not such odd cases. In 1993 Showa Sheil Sekiyu KK, a Japanese affiliate of the Royal Dutch/Shell Group, lost $US1.6 billion on currency forward contracts and Nippon Steel lost $US130 million on a currency derivatives.

Speculation risk

Going from the context of derivatives risk, it may suggest that the most significant risk can be related to uncontrolled human behaviours when a trader deliberately changes her objective from hedging to speculation as taking position or trading without authorisation. This may be relevant with the terms of Operational, Intellectual and Legal in “IS MORC ILL?� before. A trader can be attracted with an opportunity of gaining a huge profit with own strongly believed conception in predicting the future price, which is totally wrong. This may happen once she has the capacity to trade in the system.

The impact to the financial institutions or corporations in the framework of ALM is that the losses on derivatives speculation may lead to interest and currency losses which accumulatively reducing profitability and may cause a liquidity problem as the losses may drain the cash flow level immediately. Moreover, this may cause solvency problem as the market value of capital showing a negative net worth. Sometimes, this cannot be monitored properly as there is a time lag between the exercise time and the reporting time of the portfolio position and financial institutions do not mark its book value to market every time.

One popular story of rogue trader was when Barings Bank lost over $US1 billion in the Singapore futures bourse in 1995 with an unauthorized speculation in futures on Nikkei 225 stock index and Japanese government bonds. The trader, Nick Leeson had accumulated two massive open positions of Nikkei futures and Japanese government bond futures by betting on the recovery of the Japanese stock market. Unfortunately, in January 1995 a powerful earthquake shook Japan dropping the Nikkei 1000 points and brought Barings to even further loss. Lesson has not enough experience and conducted a martingale trick to gain back the money already lost. He also managed to avoid suspicion from senior management for some time.

Asset securitisation risk

Asset securitisation then can be defined as a process of transforming a series of cash flows derived from assets or business revenues of a company into securities in the capital markets that pay interests to the investors. This process needs a special purposed entity (SPE) to be formed to channel the inflows and outflows between the packaged assets or revenues and the securities sold in the capital markets. The SPE normally holds the packaged assets in its liability to be sold in the form of securities to the investors, as paying investors' interest with payments from borrowers' interests or customers' premiums passed from the originators. The SPE pays the packaged assets to the originators with the sale of securities to the investors.

In its development, asset securitization has produced a series of derivatives securities such as ABSs, MBSs, CDOs and IOs/Pos and credit derivatives securities such as CDSs, CLNs, TRSs and Synthetic CDOs. These derivatives can cover credit risks directly in the framework of ALM. The first asset securitisation type introduced in the early 1970s was pass-through securities for residential mortgages such as GNMA, FNMA and FHLMC. Here the mortgage portfolio is completely removed from the originators' asset and the trust passes the principal and interest payments to the investors. Then MBBs introduced, however, is less attractive since the loan and the securities still appear in the originators' off balance sheet. The second wave in the development of asset securitisation was pay-through securities introduced in the early 1980s, which can be viewed a combination between pass-through securities and MBBs. The most common pay-through is CMO in which the originator can structure the payments into different classes to minimise prepayment risk. Then the innovation continues as playing with the tranches with discount effect and prepayment effect. In the late 1980s, securitisation developed in other assets such as automobile loans, credit card receivable, consumer loans, trade receivables, insurance policy loans and junk bonds. In the early 1990s, collateralised debt obligations (CDOs) were introduced to attempt securitisation for commercial and industrial loans.

In the framework of ALM, asset securitisation is a short-cut technique to reshape asset portfolio by removing credit risk. If financial institutions or corporations intentionally remove the bad credits and package them through securitisation process, such banks may face three kinds of risk as follows: (1) downgrading risk arises where an independent rating agency based on its observation, analysis and perception tends to downgrade rating, (2) cost risk arises when a high cost should be paid in the process of securitisation from originating, pooling, guaranteeing, credit enhancing and selling, (3) reputation risk arise when holding a bad reputation from investors' view from securitising bad credits. Meanwhile, the risk faced by investors of the securities would be similar with the risk of lending, such as, default risk, liquidity risk, interest rate risk and additional risk of prepayment for long maturity credits, also transparency risk when the credits condition and situation are beyond investors' visions.

The consequence

Failures in ALM may lead to a liquidity problem as the hedging instruments used in it, such as short-term securities, fixed income securities and derivatives contracts and securities may expose a liquidity risk for immediate cash flow requirement. There is also a possibility that the securities cannot be liquidated immediately or the value at the time of liquidation decreases from the initial value. As funds normally used for meeting deposit withdrawals or loan demands are otherwise used for covering the loss, liquidity problem may arise. Any huge transaction in securities, derivatives or currency trading, even those are exposed in the off-balance sheet accounts, may influence the short-term liquidity condition.

Moreover, failures in ALM may lead to a solvency problem caused by mismatching maturity between assets and liabilities so that the market value of balance sheet shows a negative net worth. The changes in interest rates would affect the market values of assets and liabilities, which the cash flows are discounted at the level of interest rate. Therefore, the changes in market values depend on the changes in interest rate level and the maturities of assets and liabilities.

Early detection

The risks of financial risk management in the framework of ALM can be early detected and identified by monitoring the fair value of financial assets and derivative instruments, the current exposures of interest rate risk and market risk and the net positions of foreign currency. In New Zealand, this can be seen in a bank's general disclosure statement, which is required by the prudential supervision. Therefore, a good prudential supervision can be said to be able to limit the potential risks of risk management by observing and evaluating the current strategy of risk management that can be conducted by general public, and of course including investors. If possible and if the supervisors can afford it, the failures or losses can be rescued.

Disclosure statements consist of a Key Information Summary and a General Disclosure Statement. A Key Information Summary is provided for the non-expert investor and contains key financial information on a bank. A General Disclosure Statement is a larger document and contains a comprehensive range of financial and corporate information, such as comprehensive financial statements, including details on impaired assets and provisioning, the bank's credit rating and changes made to the rating in the two preceding years, the bank's capital adequacy ratios (measured using the standard international capital framework applied by the Reserve Bank), profitability, total assets and growth in assets, information on the number of loans made by the bank and information on the bank's risk management systems.

The objectives of disclosure in prudential supervision summarised by Geof Mortlock (July 1996, p.47) as follows:

  1. They will encourage banks to carefully manage their banking risks. Banks will face sharper incentives to manage their affairs prudently, so as to avoid the need to disclose adverse events to the market.
  2. They provide depositors and others with more relevant and timely information on banks, so as to improve their ability to decide where to bank. This is important as in New Zealand, unlike many other countries, banking supervision does not aim to protect depositors, and there is no deposit insurance. Moreover, bank deposits are not, in any sense, guaranteed by the government or the Reserve Bank. Trading bank deposits have never been government guaranteed.
  3. The disclosure framework is intended to strengthen the duty of bank directors to oversee, and take ultimate responsibility for, the management of banking risks.

In relation to the monitoring of a bank's activity in ALM, in the general disclosure statement the bank has to include the fair value of financial assets and liabilities, maturity profile, repricing schedule, current exposure to derivative instrument and the current exposures to interest rate risk and market risk and the net positions of foreign currency. Specifically, the current exposure to derivatives instruments includes the potential for further exposure should market prices fluctuate significantly, the extent to which revenues of an institution have been derived from derivatives activities and the volatility of derivative-based revenues.

After identifying the risks of financial risk management in ALM through analysis and evaluation to a bank's financial condition, the regulator can conduct further action as assisting the bank to manage the failure. The actions can be in the forms of due and diligent test, technical assistance or restricting the activity in money market and capital market. The regulator may also ask the financial institution to supply regular follow-up action reports during the process of failure management. However, this would need several legal actions and regulation instruments.

Instead of early identification, the role of prudential supervision in limiting the failures in ALM can be seen in how the regulator may actively involve in capital management. It is obvious that the worst impact of ALM failure is insolvency as the result of accumulating losses. By injecting funds to a bank's capital, the regulator can reduce the possibility of a bank failure in overall.

Circuit breakers

If the early identification is such a preventive action, a responsive action to prevent a higher magnitude of losses can be done with such a technical way in the marketplace by manipulating the trading system, as the New York Stock Exchange (NYSE) and the Chicago Mercantile Exchange use a system called the circuit breakers. This may help the losers to avoid further losses from the failures in risk management in the macro context, particularly for securities trading conducted within a very short time period, i.e., intraday trading. Then, the sufficient information needed for future decisions can be gathered effectively and efficiently in the market so that the hypothesis of market efficiency applies properly and prices fully reflect the available information, not the manifestation of market panic or distorted movement.

In the NYSE, the circuit breakers system is an imposed pause in trading that permits buyers and sellers time to assimilate incoming information and make investment choices. Circuit breakers promote investor confidence by giving investors time to make informed choices during periods of high market volatility. The set of rules approved by the US Securities and Exchange Commission are as follows. The securities and futures markets have circuit breakers that provide for brief, coordinated, cross-market trading halts during a severe market decline as measured by a single day decrease in the Dow Jones Industrial Average (DJIA). There are three circuit breaker thresholds—10%, 20%, and 30%—set by the markets at point levels that are calculated at the beginning of each quarter. The formulas for these thresholds are set forth in the New York Stock Exchange (NYSE) Rule 80B.[12]

The Rule 80B is as follows. The halt for a 10% decline would be one hour if it occurred before 2 p.m.; and for 30 minutes if it occurred between 2 and 2:30, but would not halt trading at all after 2:30. The halt for a 20% decline would be two hours if it occurred before 1 p.m.; and between 1 p.m. and 2 p.m. for one hour, and close the market for the rest of the day after 2 p.m. If the market declined by 30%, at any time, trading would be halted for the remainder of the day.[13]

In the CME, the rule would be like this. Trading in the S&P500 futures contract is halted just for a few minutes if the prices move 2.5%, 5%, or 10% from the previous close. Because restrictions on the NYSE effectively shut down trading in this futures contract, there is little need for additional restrictions on the CME.[14]

Conclusion

The main source of the potential risks of risk management in implementing ALM comes from the speculative behaviour of the authorised or unauthorised trader(s) with or without supervision from the treasury management of a financial institution or corporation. A hedging strategy is conducted with an insufficient capacity of capital, low skills in the application of risk management techniques, improper information gathered about the current market condition and interest rate environment and incorrect valuation of the current condition of the assets and liabilities portfolios. However, the level of risks of risk management can be early identified by the supervisors through the requirement of general disclosure statement to be then reviewed by general public and assisted thoroughly by the supervisors. The responsive action with Circuit Breakers in the exchanges may directly and effectively limit the losses in securities trading in a day.


Reference and Bibliography

Blue, Jacquelyn and Jean Hedberg. (2001). Identifying and managing model risk under OCC Bulletin 2000-16 and related agency mandates. Bank Accounting & Finance. Riverwoods: Summer 2001. Vol.14, Iss. 4; pg. 40. from Business Source Prime database.

CME. Circuit Breakers http://www.cme.com/clearing/clr/advntc/clien_NP_0173.html

Davies, Anthony. (1997, Feb 28). Derivatives market continues to boom despite the bad news. The Independent, p. 34. from Newztext Plus database.

Hogan, Warren. (2004). Management of Financial Institutions. Sydney: John Wiley and Sons Australia, Ltd.

Kolman, Joe. LTMC speaks. http://www.derivativesstrategy.com/magazine/archive/1999/0499fea1.asp

Mortlock, Geof. (1996, July). New Financial Disclosures For Financial institutions. NZ Business, p. 47.

National Bank takes a long cold bath in the bond market. (1995, May 19). The Independent, p. 38. from Newztext Plus database.

NYSE. Circuit Breakers http://www.nyse.com/press/circuit_breakers.html

Recent Derivatives Disasters. (1995, June 30). The Independent, p. 16. from Newztext Plus database.

Riordan, Daniel. (1995, June 30). Derivatives: Risk management for risky business? The Independent, p. 13. Newztext Plus database.

Saunders, A. (2000). Risk of financial intermediation: A modern perspective. (3rd ed.). New York: McGraw-Hill.

Sinkey, J.F., Jr. (2002). Commercial financial institution financial management: In the Financial-Services Industry. (6th ed.). New York: Macmillan, Inc.

Smithson, Charles W. (1998). Managing financial risk: A guide to derivative products, financial engineering, and value maximization. (3rd ed.) New York: McGraw-Hill.

The collapse of Barings Bank. http://www.stock-market-crash.net/barings.htm

US Securites and Exchange Commission. Circuit breaker and other market volatility procedures. http://www.sec.gov/answers/circuit.htm

Valentine, Tom and Guy Ford. (1999). Readings in financial institution management: Modern techniques for a global industry. Sydney: Allen & Unwin.



[1] Sinkey, J.F., Jr. (2002), p. 220 completely explains the three stages in ALM

[2] Saunders, A. (2000), p. 122-139 as the summary of repricing model and maturity model.

[3] Saunders, A. (2000), p. 147-149 as the summary of duration model.

[4] Hogan, Warren. (2004), p. 95-100 explains more about the situations of risk-return trade-off in DTIs.

[5] National Bank takes a long cold bath in the bond market. (1995, May 19). The Independent, p. 38.

[6] Saunders, A. (2000), p. 224.

[7] Tannenbaum, C (1999). The decline of duration. In Valentine, Tom and Guy Ford (1999), p. 449-451.

[8] Blue, Jacquelyn and Jean Hedberg. (2001). Identifying and managing model risk under OCC Bulletin 2000-16 and related agency mandates. Bank Accounting & Finance. Riverwoods: Summer 2001. Vol.14, Iss. 4; pg. 40

[9] Sinkey, J.F., Jr. (2002), p. 220 puts a mnemonic interrogatory: IS MORC ILL? from The Group of Thirty Report 1993, where MORC originally stands for Macomb-Oakland Regional Center, a Michigan mental and psychiatric disabilities centre.

[10] Kolman, Joe. (2002). LTMC speaks.

[11] Recent Derivatives Disasters. (1995, June 30). The Independent, p. 16. Newztext Plus database.

[12] US Securites and Exchange Commission. Circuit breaker and other market volatility procedures. http://www.sec.gov/answers/circuit.htm