Do you ever question whether or not your ALM model is reliable? Perhaps you’re not worried about how reliable the results are, but whether or not they’re relevant. “If you ask most financial institution CEOs and CFOs if they believe in the results produced by an interest rate risk forecast, many will tell you no,” said Dave Koch, Managing Director of Advisory Services at Abrigo. A key reason for the lack of conviction? Modeling includes many assumptions and can focus on unrealistic situations, such as a 400 basis point swing in rates. Oftentimes, modeling is used simply to to satisfy a requirement, but it doesn’t measure key areas that banks and credit unions actually care about.
In addition to modeling for the required scenarios, Koch recommends using ALM models to run forecasts on more realistic issues that the financial institution faces, such as possible movements in the market interest rates and the potential effects it may have on margins and capital. “When we spend time modeling the things that we really manage in our daily life, the things that actually cause us to lose sleep, we have a chance to make the ALM process more worthwhile,” Koch said.
To fine-tune your ALM strategy in 2020, consider these three questions:
- What is my overall performance on earnings, capital, and growth if rates don’t rise?
- Are we making enough return now?
- How much risk am I willing to take to improve financial performance?
- What can we do to maximize risk and return based on a variety of possible outcomes?
If your institution doesn’t trust your ALM model results or feels that they’re not relevant, then it’s likely that you are not able to provide answers to those questions.