Tighter Fed policy puts ALM in focus
The Federal Reserve’s signal that it will start raising interest rates in March 2022 generated a collective high-five throughout the banking industry. Bankers have been poised and waiting for interest rates to rise as they are counting on reaping the rewards of an asset-sensitive balance sheet. However, without proper planning, the joy may be short-lived. The Fed news should give bankers even more reason to consider their asset/liability management (ALM) and deposit management strategies, policies, and programs.
Generally, bankers expect the yield on earning assets to increase sooner than the costs of their deposits. However, if a financial institution is to capture any of the projected economic growth moving forward, core funding is key. Now is actually a good time to look at growing deposits.
Market volatility could generate another surge
One risk in growing deposits is that the current depositor mix includes a level of “surge deposits” that, while core in nature, are not well defined in terms of price sensitivity. To retain the surge and grow new funding, institutions may need to increase rates paid to depositors sooner and more than projected. Otherwise, they risk losing funds and customer primacy to competitors, the stock market or other investments as depositors seek even higher yields.
However, in recent weeks we have witnessed uncertainty on Wall Street about tighter Fed policy, inflation, supply chain disruptions, labor shortages, and the pandemic’s longevity. The Dow Jones Industrial Average (DJIA) has been down more than 6% over the last month, and some analysts are projecting lower returns from equities over the next decade. Plans for aggressive rate increases and a suspension of asset purchases have many firms projecting slower growth and reduced yields for equities.
If the market trends downward for long, banks and credit unions worried about money walking out the door might be surprised to find that does not happen. Financial institutions may see yet another flight to safety from investors looking for certainty after enjoying a good run in the market. As a result, financial institution deposit levels may increase yet again — a surge on surge!
If the market trends downward for long, banks and credit unions worried about money walking out the door might be surprised to find that does not happen. Financial institutions may see yet another flight to safety from investors looking for certainty after enjoying a good run in the market. As a result, financial institution deposit levels may increase yet again — a surge on surge!
What’s your deposit management strategy?
Pricing the existing deposits profitably while considering the potential new surge requires institutions to have a strong plan thought out in advance for product and pricing approaches to manage marginal costs. They also need to act quickly on deploying these funds into appropriate assets to manage the margin.
How will a financial institution know which customers will do what and how to take advantage of the opportunities presented?
Understanding the makeup and behavior of depositors over time through various cycles is key. This understanding across cycles needs to include:
- Attributes related to demographics, generational factors, and relationships
- Market rate correlations to pricing
- Rate sensitivity
Armed with this knowledge, an institution can strategically develop appropriate pricing and mix strategies to take advantage of opportunities to grow the deposit base. Additionally, considering how long accounts are likely to stay on the balance sheet can help leaders identify how to best leverage their deposits to provide low-cost funding to finance strategic growth.
Today, the asset/liability management process is front and center to ensure margins act — as so many hope and believe they will — as rates increase.
Susan Sharbel brings over 35 years of expertise in the banking industry, with a focus on asset/liability management and regulatory compliance. Prior to joining Abrigo, she was an ALM consultant leading ALM model implementations and managing the quarterly ALM process, support, and analysis for nearly 40 banking clients. As a Senior Advisor in Abrigo’s Advisory Services Group, Susan consults with financial institutions on their overall asset/liability management needs.
Dave Koch is Director of Advisory Services with Abrigo and a lead faculty member of the Graduate School of Banking – Madison. Dave works with financial institutions on their capital planning, strategy development, loan & deposit pricing, and overall Asset/Liability management to meet the earnings and growth needs while managing regulatory concerns for his clients.
