Over the past several years, the banking industry has seen seismic shifts in deposits as trillions of dollars in Government stimulus were released into the economy, followed by a period of dramatic increases in market rates, which then resulted in massive amounts of low yielding balances migrating into higher-paying CDs and non-bank investment products.
Establishing and maintaining a sound interest rate risk (IRR) management program is crucial to ensure proper balance sheet structure and comply with Regulatory expectations. During my 20+ years as a senior FDIC examiner, I routinely saw organizations experiencing issues with their ALM/IRR practices, ranging from loose misunderstandings of the guidance to critical errors that put the health of the organization at risk. Unfortunately, in my current advisory role, all too often, I see the same issues.
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.
In the last two years, the Fed has implemented 11 increases in the target Fed Funds rate, amounting to a total of 525 basis points. These moves were aimed at tempering the overheated economy in the wake of the COVID pandemic.
As a result of these increases, we have seen massive shifts in deposit balances as consumers have become more aware of opportunities to move balances from lower yielding non-maturity deposits into higher yielding CDs and alternative investment products. While we can’t be sure of what future market rate movements will be, or when they will occur, every financial institution must be prepared for any outcome.
Considering this era is marked by economic uncertainty and rapid shifts, understanding liquidity's critical role continues to be paramount. Here are three key reasons maintaining a strong liquidity risk management program in 2024 and beyond is not a suggestion, but a necessity for community banks and credit unions.
"Which measurements would you put highest priority on in 2024?"
I’d say that Net Interest Margin (NIM) changes and Economic Value of Equity (EVE) should continue to be the primary focus of IRR management in 2024. Gap calculations rarely give the full picture (focused on timing of reprice, and not magnitude), and Duration measurements can be difficult to understand. Given the extreme rate increases in the past two years and the bank failures in 2023, all financial institution managers and directors should have a clear understanding of how future market rate changes could impact both shorter-term earnings (aka the NIM in the next one and two years) and longer-term capital values (aka the EVE).
For the past few years, I’ve written about the varying circumstances surrounding Surge Deposits. From “the death of” to the “resurgence,” it seems to be a consistently hot topic – this year, with a slight twist. While previously keeping a close watch on the influx of demand deposits, we’re now seeing increased pressure on funding flowing either from non-maturity deposits (NMDs) into higher costing CDs, or out of financial institutions all together.
Before we get further, if you haven’t yet read my other blogs discussing Surge Deposits, or could use a refresher, click here to do so.
It was only two months ago we released a blog discussing the critical role that liquidity management will play in 2023. Fast forward to now, and two financial institutions have been closed due to, at least in part, funding imbalances – the first banks in three years to fail. Although liquidity and interest rate risk often take a backseat under stable economic conditions, times like these require you to take an in-depth look into your asset liability management program to ensure you have a plan to both meet funding needs and stay in compliance with regulatory expectations.
About two years ago, I wrote a blog declaring the end to, or “the death of,” Surge Deposits. In that post, I had noted how at the time of, and following the 2007-2009 Great Recession, the banking industry saw a substantial influx of deposits as real estate and equity investors liquidated positions and sought safe places to store their money and ride out the storm. I further noted that as CD rates plummeted during, and following, the economic crisis, CD holders weren’t being provided with any incentive to have their money “locked” into time deposits. As time deposits matured, CD holders routinely moved their balances into more liquid non-maturity deposits (NMDs). These former CD holders were essentially temporarily “parking” their money in NMD accounts, just waiting for CD rates to return to what they believed were more “normal” levels, at which time they’d move the balances back into time deposits.
The Fed has officially raised rates, with the intention of continuing to do so several more times this year. What does that mean for your financial institution, and how will it affect your Budgeting and ALM/IRR programs in 2022? Let’s focus on a few areas of concern, specifically Financial Reporting, Strategic Decision Making, and Board/ALCO oversight.
Regulatory guidance states that the board of directors has the ultimate responsibility for the risks undertaken by an institution – including interest rate risk (IRR) and liquidity management.
The board is typically made up of a diverse group of individuals from varying backgrounds and career paths. Unlike most positions within a financial institution, a board member does not necessarily come from a banking background. One board could easily include a local entrepreneur, a farmer, a financial planner, a retired financial institution CEO, and a local insurance agent; while another board could be comprised of almost all former bankers. It’s often the most differing group in a similar role across financial institutions – so, since one size does not fit all, how do you train directors for their position on the board?