"In the 1981 film, "Raiders of the Lost Ark", one particular scene consistently brings the house down: Indiana Jones, having survived an elaborate chase through a casbah, is confronted by a swordsman whipping through a flashy routine with a scimitar. Indy initially squares off against the deadly swordsman bearing only his trademark whip in his hands; then with a look of infinite fatigue and disgust, he casually pulls out his revolver and blows the bad guy away." (Credit for text: Snopes.com)
This scene often comes to mind when I read articles about Asset Liability Management (ALM). To that point, a recent publication spurred me on to rant a bit about this today. Here’s how the article started:
'This is a very important technical article…” and later in the opening paragraph, 'the first part will begin with the methodology that is simple and transparent…”.
Important? Yes, to the author. Technical? Indubitably! The following is one of nine formulas he offered as “simple and transparent”:
I feel like I’ve just experienced an elaborate chase through a casbah.
The article also suggests that it is these 9 formulas that derive best practice yield curves for a “…full array of risk management calculations…” and lists the usual suspects (interest rate risk, cash flow modeling, etc.).
Maybe this article just bad bad timing, so I'm picking on it; however, this isn’t the first article in which overly complex solutions are suggested for what many community bankers already consider an enormous burden.
For our tagline, we use "Simplifying Complexity." Why? Because we believe that being able to get to the results efficiently, in a fashion that is understandable and easy to do, produces the most meaningful results.
Thus, my 'Indiana Jones Sword vs. Gun Theory.' This theory proposes that using many complex maneuvers to reach an end (i.e. “flashy routines") loses sight of the simple, cost effective, and good enough methods to satisfy a need. Like in the case of Indiana Jones, if the swordsman had a gun instead, the movie might have ended right there (far less entertaining).
In banker’s parlance, it just does not matter if the value at risk at +400 basis points is inexact by 5%-10% because it does not represent a liquidation value (see "When “Market Value” Really Isn’t Market Value"). Put another way, if the +400 rate shock represents a low probability, high impact event and is not useful for managing a community bank’s day-to-day activity, isn’t knowing that the impact is directionally correct and within a reasonable estimate of loss good enough? What value does this extra exactness (ie. the fancy sword routine) provide in return for the amount of effort to get there? Make it less complicated and use the gun.
I’ll give the author this: if his methodology is being used by bond dealers to calculate exact value for purchase price then, yes, use these formulas to get your results. But please (all you scholars), stop trying to convince community bankers they need to go to such lengths of exactness. All they really need is Indy and a look of infinite fatigue.