Over the last decade and a half, there has been a sort of dance when it comes to deposit stability. Following the Economic Crisis, we saw a massive “surge” of funds into banks and credit unions as depositors sought safety and a place to “park” money until better returns were again available in the market. In early 2020, after market rates had jumped a bit, I crafted a blog declaring the death of surge deposits, but then quickly had to shift as we saw a new round of “surge deposits” following the Government’s release of trillions of dollars in Covid-related Stimulus funds. Then, as deposit rates shot up in 2023, we saw a massive movement of funds from low-cost checking and savings deposits into higher-yielding CDs and MMDAs. Now, as we near the end of 2024, we’re left with a lot of deposit-related questions. Specifically,
To help answer those questions (ones examiners will certainly be asking), we’d strongly suggest that you be sure that your asset liability management program includes backtesting, sensitivity testing, and decay rate and deposit trends studies.
Backtesting
Backtesting is a process of comparing actual versus forecasted results. The exercise should not just test IRR model results, but also key model assumptions. The goal of backtesting is to gauge model performance in times of changing market rates, and thereby identify possible areas to adjust the model (change assumptions, inputs, scenarios, etc.) to improve its predictability. Annual backtesting should suffice, unless market conditions are particularly tumultuous and market rates have tremendous fluctuation.
If you’d like to dive deeper, I’ve written several pieces detailing the ins and outs of backtesting, from top questions to why it’s so important. To review them, click here.
Sensitivity Testing
A form of stress testing, sensitivity testing will also be an annual hot-button initiative for any financial institution – especially come exam time. Sensitivity testing aims to identify model vulnerabilities and stress test worst-case scenarios. Sensitivity testing involves making material changes to key model assumptions in order to determine which assumptions have the most impact on model results. Whether conducted in-house or by a third-party, regulators want to see that organizations are adequately testing the assumptions they have in place to ensure that capital adequacy is planned for and inherent risks are mitigated.
At Plansmith, we suggest that, at a minimum, your sensitivity testing program include three separate sensitivity tests focused on the Regulatory-identified key model assumptions of asset prepayments, non-maturity deposit repricing, and non-maturity deposit decay rates.
Decay Rate and Deposit Trend Studies
While the “surge deposit” era appears to be behind us, that doesn’t mean the implications of all that deposit movement has completely worn off of your balance sheet. Now, decay studies will be paramount to understanding the behavior of your current non-maturity deposits. Be sure that those studies also include a full deposit trend analysis that considers how your deposit levels and mix have changed in recent years and what impact that might have on future deposit stability. By reviewing current accounts, closed accounts, and run-off rates, you’ll have a solid view into the volatility of your deposit portfolio.
Next Steps
We understand that these types of analyses can feel overwhelming, depending on an organization’s resources. Plansmith’s team of former examiners can help alleviate the burden of these compliance-related activities quickly, effectively, and affordably. Click here to discuss your unique needs.
Director of ALM Advisory Services