Andrew Okolski, The Baker Group As if navigating the 2008 Housing Crisis and the 2020 Global Pandemic weren’t enough, banks now face the most feared economic monster of all — inflation. CPI YOY jumped by 8.6% in May 2022, backed by broad price increases across many sectors. Obviously, this is well above the Fed’s average target of 2% and increases the chances of more severe economic headwinds. If the Fed aggressively fights inflation through higher rates and balance sheet reduction, it will add significant downward pressure on consumers and the overall economy. If they are not aggressive enough, inflation can remain elevated for a longer period, also adding significant downward pressure. I think everyone was hoping for a bit of a breather coming into 2022; however, we instead find ourselves in an equally challenging situation where asset pricing and ALM strategy are of the utmost importance. For most of the past two-plus years, income and capital pressures kept many up at night. The good news is that today’s higher yields offer quick relief in those categories. Unfortunately, we now have some new pressures coming from falling asset market values. While every institution is unique, managing interest rate risk (specifically market risk) can almost always be improved by including EVE and Income Simulation results. Doing so is key when discussing overall asset pricing and the difference between ALM results and executed strategy. It’s important to note that the rate of change is just as important as the overall amount of change when it comes to asset/liability management. This is why asset pricing becomes so important in this volatile interest rate environment. The faster interest rates rise, the greater the negative impact on our EVE in particular. The main reason is that quick rate movements give depository institutions little time to react and adjust their asset yields. We can only add higher-yielding investments and write higher-yielding loans so fast. Often this means that the first few quarters during a rising rate trend can magnify and even potentially overstate our IRR risk as measured through EVE. So, what can we do to combat this? The Importance of Asset Pricing and ALM Strategy NEBANKERS.ORG 22
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