15 Hoosier Banker April 2016 DIRECTORS / SENIOR MANAGEMENT As instructive idioms go, “hope for the best, but prepare for the worst” is a good one. While recognizing the human tendency for optimistic expectations, it acknowledges the practical contingency that an undesirable outcome may occur. It also exhorts us to be ready for it. For community bankers trying to prepare for a higher interestrate environment, the exercise of modelling the potential risks to earnings and capital is an attempt to do just that. By projecting the changes that happen to interest income and interest expense when the repricing of earning assets and paying liabilities occurs in higher-rate scenarios, risk managers can quantify the potential results a higher-rate climate might produce. In a recently published “Range of Practice Memorandum,” results of surveys conducted by the Office of the Comptroller of the Currency reveal that only a small number of institutions reported elevated levels of interest-rate risk. Quite naturally, the reported risk measurements were the surveyed banks’ modelling results, and that’s where hoping for the best collides with preparing for the worst. The Past May Not Be Prologue Regulatory authorities, aware that a variety of assumptive inputs are part and parcel of the interest-rate risk measurement process, continue to remind us of their expectation that assumptions are reasonable, institution-specific and supported by empirical evidence. Assumptions, however, despite the efforts expended and resources utilized in their genesis, are still assumptions; their accuracy never comes with a guarantee. In the context of the postcrisis business cycle and economic recovery process, and the manner in which these events and conditions differ from historical patterns, even the reliability of time-tested causal relationships comes into question as a predictor of future behavior. Nowhere are these circumstances more relevant and the related assumptions more apt to be questioned than in the modelled portrayal of those assumptions governing the behavior of non-maturing deposits (NMDs). Despite the oftentimes-exhaustive efforts to produce assumptions that will help management anticipate the behavior of the owners of those deposits, such efforts still leave many questions unanswered. The three most relevant questions that seem to be on the minds of many relate to price sensitivity, balance stability and the impact of disintermediation: • Will the historically low beta price sensitivity of NMDs continue into a higher-rate environment, or will yield-starved customers demand a greater degree of market sensitivity? • Will the long average lives characterized by the unflaggingly core-like nature of NMDs play out as expected, or will these accounts become more volatile with higher decay rates? • Will these surging deposits even stay in the bank, or will they have to be replaced by costlier funding alternatives? How the Cow Ate the Cabbage Are Your Interest-Rate Risk Reports Giving You the Unvarnished Truth? About the Author Lester F. Murray, associate partner of The Baker Group, joined the firm in 1986. He previously worked for the Office of the Comptroller of the Currency as an assistant national bank examiner and is a frequent speaker at investment conferences and educational seminars. Murray is a graduate of Oklahoma State University. The author can be reached at 800-9372257, email: lester@GoBaker.com. The Baker Group is a Diamond Associate Member of the Indiana Bankers Association and an IBA Preferred Service Provider. Continued on page 16.
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