Plansmith Blog

Risk is inevitable in banking; in fact, it’s what makes banking profitable. The question is, how much risk is acceptable? Recognizing that existing techniques of measurement were sometimes misleading and arbitrary, Plansmith developed a simple calculation called "Margin Risk Tolerance" that defines how much risk each bank can take. Despite the wealth of banking information Plansmith has at hand, we believe risk relates to the individual bank, and cannot be measured to any peer standard or magic number.

Margin risk tolerance calculates the minimum net interest income and net interest margin necessary to maintain continuing operations. Minimum margin consists of two basic components: 1) earnings needed to maintain an acceptable capital ratio and pay dividends, and 2) earnings needed for overhead.

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.

"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.

For six wonderful years, I’ve had the privilege of being a part of Plansmith’s marketing team. From marketing assistant, to department manager, to my most recent role as Director of Marketing, I’ve experienced firsthand how important our company’s mission is: improving planning. Why? Because there is nothing more frustrating than having a brilliant idea with no real way of making it come to fruition. However, with incredible people and a quality plan, anything is possible – and doable.

Like many of you, I notice how important the planning process is when I’m putting together my ideas for next year. Though a marketing plan is a bit different than financial institution planning, the core concepts are the same.

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?

Is IRR and Liquidity Cash Flow Model Outsourcing Right for You?

That is a question a lot of CFOs and Presidents struggle with. Here at Plansmith, it really doesn’t matter to us whether you run the model yourself, or you outsource it to us. In fact, we have many clients on both sides of that fence, and even some that do a little of each. We just want you to be comfortable with whichever option you choose, be confident in your model results, and be sure your ALM process will pass the test at regulatory exams.

Times are strange. We haven’t been in our Plansmith offices together since March 16^th. That’s over a hundred and sixty days – it feels crazy. But like with anything else, we adjust and move forward to reach our goals, but the plans for getting there have definitely changed.

We still want to get together with everyone. We still want to talk about what works, what doesn’t, and how things are going. Even though we can’t meet face to face at our Schaumburg offices this year, we can still come together virtually!