30 JULY / AUGUST 2020 FINANCIAL MANAGEMENT The world has changed. The nation’s economic lockdown has given previously confident consumers a new and cautious attitude of frugality. The propensity to borrow and spend has turned into an inclination to deleverage and save. Once prosperous businesses struggle to stay afloat as society and culture adjust to a new, post-pandemic playbook. Municipalities and political subdivisions are faced with the challenges of impaired revenue streams and eroding tax bases. The nature of community banking is not immune to the changes being wrought and will no doubt be further changed by variables not yet contemplated. Something that few contemplated as recently as year-end, a return to a Zero Interest Rate Policy (ZIRP), is now upon us and will likely be upon us for the foreseeable future. Risk Comes to Work Every Day As bankers across the country rally to meet the needs of their customers and communities, it’s understandable that the intricacies of interest rate risk management may have taken a back seat to more pressing issues. But, like an essential employee, interest rate risk shows up at the bank every single day, and that’s not going to change. What has changed for most, if not all, community banks are the characteristics of their balance sheets’ risk profiles. The direction of repricing has become universally down for both asset dollars and liability dollars, but not by the same degree. The volumes of those dollars Interest Rate Risk Doesn’t Do Quarantines subject to repricing may have significantly changed, too, as the ultra-low rate environment affects the prepayment behavior of mortgage-backed securities along with the likelihood of optional call features being exercised by bond issuers. Not to be forgotten, the level of prepayments experienced by banks’ own notecases are being affected also. Don’t forget about liquidity, either. The establishment and maintenance of reliable sources of funds is a perennial priority with bankers and supervisory agencies alike and, in the present environment, the regulatory scrutiny of such things is likely to be intense. Don’t Assume Your Assumptions Are Still Valid The regulatory scrutiny of the many assumptions used for interest rate risk modeling exercises is also not new and may be just as intense while society transitions from almost total lockdown to partial reopening and ultimately to a reinvented “new normal.” No one knows exactly how these processes may play out, nor how human behavior may be affected by them. Humans, after all, make up the vast majority of community banks’ customers. How they behave influences how those banks, and the risks they contain, are managed. History May Not Repeat Itself, But It Does Tend to Rhyme This is not a new consideration, and the establishment of ZIRP by the Fed during the subprime Lester Murray Associate PartnerFinancial Strategies Group The Baker Group lester@GoBaker.com The Baker Group is a Preferred Service Provider of the Indiana Bankers Association and an IBA Diamond Associate Member.
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