anaging interest rate isk in a rising rate environment · deposit mix relationship between fixed...
TRANSCRIPT
Views expressed are those of the presenter and are not necessarily those of the Federal Reserve Bank of
San Francisco or the Board of Governors.
MANAGING INTEREST RATE RISK IN
A RISING RATE ENVIRONMENT
December 5, 2013
Wallace Young
Mr. Young is Director of the Risk Coordination Unit at the Federal Reserve Bank of San
Francisco. He joined the Reserve Bank in 1999. In his current capacity, Mr. Young
oversees a team of Risk Coordinators that are responsible for monitoring key banking
risks and supervisory issues, providing guidance and consultative services to
supervisory staff, and working with counterparts throughout the Federal Reserve System
to develop and deploy regulatory and examiner guidance.
Jeffrey Plaskett
Mr. Plaskett is a Senior Examiner and Market & Liquidity Risk Coordinator at the
Federal Reserve Bank of San Francisco. He has over fifteen years of regulatory
experience, covering market and liquidity risk issues at community, regional, and large
financial institutions. He also previously chaired the Federal Reserve’s Market Risk
Coordinator Affinity Group. In his current role, Mr. Plaskett is responsible for
monitoring emerging interest rate, market, and liquidity risks in the 12th District.
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Today’s Presenters
Agenda
• Why is Interest Rate Risk a growing concern?
• Why are assumptions becoming more
important?
• What should bank management teams be doing
about this issue?
A Q&A Session will Follow the Prepared
Remarks
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Source: www.treasury.gov
Treasury Yield Curve
Long Term Interest Rates are Increasing
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0.62%
1.41%
2.0% 1.5%
-0.4%
3.6%
2.7%
-0.1%
1.6%
1.0%
-1.2% -2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13
5-Year Treasury Rate
Small < $1B
Mid-Sized $1B - $10B
Large > $10B, excluding Wells Fargo
Unrealized Gains (Losses) on all
Securities / Equity – 12th District Banks in
Aggregate
Investment Portfolios are Declining in Value
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Earnings-at-Risk
Measures extent to which a
change in interest rates will
reduce a bank’s Net Interest
Income.
Capital-at-Risk
Measures extent to which a
change in interest rates will
reduce a bank’s Economic
Value of Equity (EVE).
According to their own models, most
banks are positioned to benefit from
rising rates. But, this is largely
dependent on many important
assumptions.
Unrealized losses are only realized
when the bank sells the investment.
But, unrealized losses do limit the
bank’s flexibility and ability to
generate liquidity.
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Deposit Growth & Mix
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0%
5%
10%
15%
20%
0%
20%
40%
60%
80%
100%
4Q1985 4Q1988 4Q1991 4Q1994 4Q1997 4Q2000 4Q2003 4Q2006 4Q2009 4Q2012
Fed
Fu
nd
s R
ate
(%
)
% o
f T
ota
l D
epo
sits
Deposit Mix
Recession
FF (right)
Time/Total
Deposits
NMD/Total
Deposits
Source: Call report
1985-2008 Average: 62%
1985-2008 Average: 38%
83%
17%
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Deposit Assumptions
• Deposit assumptions have a significant impact on Interest Rate
Risk measurements.
• The current environment may provide misleading data for banks
if data trends are not properly analyzed.
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Assumption Definition
Beta Relative repricing rate assumed for deposits versus a benchmark
rate
Account Balance Projected balances assumed over a stated time horizon
Deposit Mix Relationship between fixed vs. floating interest bearing accounts
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Case Study
• Sample Bank has historically funded its operations with core deposits.
• Deposit mix has shifted dramatically toward non-maturity deposits over the last few years, which have seen above historical average deposit growth.
• Asset side of the balance sheet has seen growth in investment portfolio (primarily Mortgage Backed Securities) and fixed rate loan portfolio.
• The bank calculates its Earnings at Risk (E@R) exposure to a parallel 200 basis point rise in rates to be positive 5.8 percent (an increase to net interest income).
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• How do changes to key deposit assumptions affect
Sample Bank’s E@R?
– Betas: Increase institution's assumed repricing rate on
non maturity interest bearing deposits by 20%
– Account Balance: Project impact of a 10% decline in
noninterest bearing deposits
– Deposit Mix: Reallocate the mix of total domestic
deposits back to 2000-2008 period of Time/Non-maturity
Deposits
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Case Study
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Case Study
5.8%
3.6%
-0.4%
-1.5%
E@R at + 200 bps E@R with Beta adjustment
E@R with Deposit Mix adjustment E@R with Deposit Decay Adjustment
Earnings at Risk Analysis
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1. Conduct critical reviews of assumptions used
in interest rate risk measurement process.
Focus on non-maturity deposits.
How will “surge”
deposits behave?
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2. Stress test your assumptions.
Pay more attention to those assumptions that
are more significant to the outcome.
If we changed this
assumption “X%” what is
impact on overall
exposure?
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3. Evaluate impact to interest rate risk when
making investment decisions.
Determine if the proposed security will
increase or decrease interest rate risk, prior to
making the purchase decision.
Is that small, additional
yield worth the extra
interest rate risk?
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4. Validate your interest rate risk modeling
process.
Important models and risk management
systems should be subject to ongoing,
periodic validation and audit. How confident are you
that your interest rate risk
measurement process is
working?
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5. Ensure robust discussions with the Board.
Ensure the Board of Directors fully
understand the institution’s risk exposure.
Do the directors understand
how interest rate changes
will impact the institution’s
earnings and financial
condition?
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For further information and resources:
• Joint Policy Statement on Interest Rate Risk (May 23, 1996)
• Interagency Advisory on Interest Rate Risk Management (January 6, 2010)
• Interagency Advisory on Interest Rate Risk Management Frequently Asked Questions (January 12, 2012)
http://www.federalreserve.gov/bankinforeg/topics/market_risk_mgmt.htm
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