Managing the bank or credit union
Asset/liability management professionals often ask me for advice on using their ALM model to generate reporting that will provide meaningful information to aid in financial institution management. What types of ALM reports would be most helpful for banks and credit unions to run, and why?
Below are several examples of asset/liability reports that can help financial institutions manage during a changing environment and prepare for future changes.
Beyond balance sheets
A balance sheet and an income statement certainly provide information for most banks and credit unions. But what happens in a different rate environment? What happens when interest rates are changing and the institution’s prepayment speeds also change? What happens to your financial institution’s interest margin, the balance sheet, and, ultimately, what happens to net income as these changes unfold?
We are now in the middle of some significant rate hikes. What impact has the rising-rate environment had on our financial institutions? What has happened to our net interest margin? How about liquidity? Also, we have not thought about down movement in rates for a long time as there was simply nowhere to go. But with rates moving up over 500 bps in the last 18 months, now is the time for financial institutions to look at and review all down-rate shocks, our policy limits, and how the institution is positioned.
ALM insights
While reports using immediate and permanent rate shocks fill a regulatory need, they are not very useful and don’t provide much insight for the bank or credit union. Rates change over time, and not all rates move by the same amount or, in some cases, in the same direction, so their impact on the balance sheet, income statement, and economic value of equity (EVE) can be difficult to discern.
As proof, consider how rates in the last 18 months did not move immediately and permanently by 100 bps or more; they moved over time. Financial institutions need to take into account different types of rate environments and the non-parallel, inverted, flattening, and steepening curves that can play out over two to three years.
For example, if my institution has a $1 million bottom line in a flat-rate environment and interest rates run up 20 or 30 bp over the course of a year, will I see what’s happening by running a one-year forecast? Not really. I need the ability to look out for two or three years to see what the full impact of those rate changes might be. What if the rates move differently than they have been? I need the ability to run forecasts for multiple environments using different yield-curve shapes and yield-curve rate changes.
What if rates fall? A one-year report, similarly, would not allow us to see the full impact of the rate changes on liquidity, capital, and various components of the income statement. Two- and three-year reports would be better.
That way, no matter how interest rates unfold, there is a level of comfort that the financial institution’s results will be within those produced when running different rate environments.
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Run monthly
At a minimum, your analysis for interest risk management, liquidity risk, and capital planning should include the following eight reports from your asset/liability management software. These can provide valuable insight that will help assess the impact of changes before they hit the balance sheet or income statement. An institution can use these reports to give the management and board the ability to adjust their business plan to ward off big hits in their bottom line and to seize opportunities competitors might miss.
Once any of these reports has been set up in your ALM model, using it each month is easy and reduces the chance that a setting may get missed or changed.
Asset/liability analysis
The asset/liability management reports and the insight they’ll provide are:
As mentioned earlier, once you set up these reports in your ALM model, it’s easy to use them each month for asset and liability management. Your ALM advisors can help you if you need to know how to generate reports in the ALM model. With these reports, a financial institution will be better prepared to face the interest rate risk and liquidity risk that changing times can bring. It will be able to test strategies to see what adjustments could benefit the bank or credit union as the future continues to change. Do your competitors have that advantage?
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