To the average person interest rates aren’t given a second thought until you need to buy something. “Oh, we really need a new car but wow I didn’t realize rates were so high!” is a statement you might encounter out in the wild but to those of us in the banking industry, it is a top of the mind concern. While rising rates are often welcomed by banks as they can allow for margin expansion, there are challenges that can come with a rising rate environment and Silicon Valley Bank and other events earlier this year showcased that fact.
Effective interest rate risk management is an essential component of safe and sound banking practices and that is an opinion shared by our federal regulators. Interest rate risk was one of the top noted concerns of the OCC in its 2024 Operating Plan which we wrote about previously. Have You Thought About Interest Rates Lately? due to inflation, geopolitical concerns, and rescission worries. While interest rate risk modeling will continue to be a challenge, there are several practices you can incorporate to ensure that the range of interest rate risks and any exposures are well understood. The following are a few things to keep in mind as you think about your new year.
Due to the rate environment during the pandemic and now the rising rates of the last year, many institutions reduced the focus on down rate scenarios given the unlikely scenario of a negative rate environment. However, given the current rate environment, it may be beneficial for management teams to reinstate down rate scenarios in their modeling practices as inflation worries seemingly taper off. Additionally, management may want to consider the importance of running and analyzing alternative rate scenarios given the movement in rates experienced this past year.
Deposit assumptions typically have a significant impact on interest rate risk model results and should be a consideration as you revisit your models. Given the current deposit and rate environment, it may be a good time for management teams to revisit deposit assumptions, to ensure that they accurately reflect current and forecasted customer behaviors.
Given the difficulty of developing assumptions that are accurate for all scenarios, banks may want to consider placing more focus on sensitivity testing to ensure that the range of interest rate risk is well understood by management. Effective sensitivity testing includes isolating one assumption and ensuring that it is appropriately stressed to understand how it drives a range of interest rate risk results.
You do not want to be the person caught off guard by interest rates. The FDIC has some very helpful resources on interest rate risk that we’d advise looking over. As always, please feel free to contact our Compliance Alliance hotline team with any questions or concerns.