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Managing interest rate risk in 2024: Strategies for community banks

Kate Randazzo
June 28, 2024
Read Time: 0 min

Navigating interest rate management in today's environment

As regulators focus on interest rate risk management, read about what financial institutions can do to be ready for a rate drop.


You might also like this on-demand webinar, "Navigating uncertain times: Strategies for effective risk management and compliance."


Rising-rate environment

Planning ALM strategies

In today's volatile economic landscape, managing interest rate risk has become a top priority for community banks. According to a recent poll by Abrigo, 56% of financial institutions expressed heightened concerns about managing interest rate risk this year. This blog will explore practical strategies for managing interest rate risk. It is the first in a series of blogs on navigating the uncertain times bankers find themselves in, drawing on insights from industry experts at a recent Abrigo webinar on risk management.

Managing interest rate risk is at the forefront of many bankers' minds, and for good reason. The market has seen significant fluctuations, and with the Federal Reserve's recent actions, the banking sector is experiencing unprecedented challenges. Inflation continues to rise, affecting everything from consumer purchasing power to borrowing costs. As Abrigo Senior Consultant Susan Sharbel pointed out in a recent webinar, "We are in a high interest rate environment that affects our economic growth and borrowing costs, and it's something we need to navigate carefully."

Planning ahead

The impact of changing rates on bank margins

With unusually high interest rates comes an exceptionally high increase in basis points—and Sharbel estimates that across all FDIC institutions, banks and credit unions have seen a rise of 525 basis points.

“It’s not the only time such a large increase has happened, but the assets are not moving at the same rate as the liabilities, and most institutions are asset-sensitive. That means that more assets are sensitive to repricing than liabilities,” Sharbel said. “The yield on earning assets increased faster than the cost of funds. When rates rise, asset-sensitive banks tend to benefit. With the volatility we are seeing, the real concern is what happens when rates fall.”

What happens to the liability side when rates fall? With competition from nontraditional fintech companies, there is some concern that banks and credit unions will not be able to drop funds as quickly as they have in the past. Sharbel predicts we will see serious margin compression if they can't. Understanding the impact of changing rates on your financial institution’s margin is critical to plan what to do next.

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Strategies for 2024

Key components of managing interest rate risk

These five areas of focus can help financial institutions improve their standing and prepare for the future. When it comes to managing interest rate risk, data-driven strategies can be the difference between a financial institution and its competition. Consider the following items a checklist for equipping your bank or credit union for rate changes.

Robust interest rate risk models

Sharbel emphasized the importance of having a robust interest rate risk model. "You should be using the most robust interest rate risk model that you can afford," she said. “It's not just about current conditions but also about where your strategies are leading you. Your model should be able to capture all relevant risks and assumptions.” Some common pitfalls Sharbel sees are the inability to incorporate lag on deposits or capture balloon payments in the loan portfolio. “Certainly, in this volatile market, we want to see that you’re checking every assumption that is going into your model to make sure that you can identify, measure, monitor, and control your risk.”

Dynamic scenario analysis

One effective way of managing interest rate risk is through dynamic scenario analysis. This involves incorporating strategic pricing and growth projections into your earnings at risk models. By doing so, you not only manage the risk in your current portfolio but also anticipate risks in your future portfolio. This comprehensive approach ensures that you are prepared for various economic scenarios.

Diversification of loan and investment portfolios

Diversifying your loan and investment portfolios can mitigate concentration risk and enhance stability. Sharbel noted that the infamous Silicon Valley Bank failure began as a concentration risk that became an interest rate risk and, ultimately, a liquidity risk, which can happen quickly if risk is not managed correctly. By spreading investments across different asset classes and sectors, banks can reduce their exposure to any single economic event or market downturn.

Backtesting, core deposit studies, and loan prepayment studies

Backtesting is not new, but regulators have increased their scrutiny of institutions’ backtesting practices. “Backtesting gives you a confidence level in your model that will help you depend on your model and make decisions based on your model comfortably,” Sharbel said. Even if the results of a backtest aren’t what you expected, regulators will appreciate that your financial institution is documenting what has happened and why you think you can still have confidence in your ALM model.

Sharbel also recommends a loan prepayment and core deposit study if your financial institution hasn’t done one recently. Performing these tests on key assumptions helps banks understand how different economic conditions could impact their portfolios and overall financial health. For instance, what happens to your liquidity if there is a significant runoff of large deposits? Understanding these scenarios can reveal vulnerabilities and guide your strategic planning.

Capital and liquidity management

Maintaining a strong capital position and managing liquidity are foundational to managing interest rate risk. A capital buffer is essential to handle unexpected events like global pandemics or economic crises. Ensuring adequate capital and liquidity buffers can help absorb shocks and stabilize during turbulent times. Sharbel also noted that it's important to understand both your institution’s pricing behavior and your customers’ behavior in terms of longevity. Customers are paying attention to your rates, and you need to understand what will happen when those rates fall.

Applying to today

Practical steps for today's interest rate risk environment

To put these strategies into action and optimize managing interest rate risk, community banks can:

  • Regularly update and validate their risk models: Ensure that models reflect the latest market conditions and regulatory requirements.
  • Conduct regular scenario analyses and stress tests: These and other reports can help anticipate potential risks and develop contingency plans. 
  • Review and adjust portfolios periodically: Regular reviews can help identify and mitigate concentration risks, ensuring a balanced and diversified portfolio.
  • Engage in continuous dialogue with regulators and stakeholders: Keeping open lines of communication can provide valuable insights and ensure compliance with evolving standards.

Managing interest rate risk is a complex but essential task for community banks. For more insights and tools on this topic, read the next installment of this blog series or contact Abrigo's team of expert ALM advisors.

This blog post was written with the assistance of ChatGPT, an AI language model, and was reviewed by Abrigo.

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About the Author

Kate Randazzo

Content Marketing Manager
Kate Randazzo is a Content Marketing Manager at Abrigo, where she works with industry thought leaders to create digital content that helps financial institutions better serve their customers. Before joining Abrigo, Kate managed social media and produced articles for Campbell University’s quarterly magazine and other university content initiatives. She earned

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About Abrigo

Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo's platform centralizes the institution's data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth.

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