Pub. 4 2013 Issue 3

fall 2013 23 West Virginia Banker For those managers of interest rate risk who are concerned that non-traditional depositor behavior may have an adverse effect on traditional deposit behavior, it would serve them well to adjust the assumptions under which these nouveau deposits are being modeled. Using the current convention of long average lives and high durations, non-maturing deposits enjoy significant appreci- ation when their fair values are “shocked” under higher interest rate scenarios. For many community banks, this offset to asset value depreciation is the primary reason their Economic Value of Equity holds up so well when these rate shock exercises are per- formed. If the owners of these accounts engage in behavior that results in shorter average lives and lower durations, the expected appreciation of the fair value of liabilities becomes an illusion and the exposure to potential EVE depreciation can greatly increase. Capital adequacy is not the only potential misread that might be the result of unrealistic behavioral assumptions. Banks whose modeling results indicate that they are well positioned for im- proved earnings should rates rise might want to know what could happen if those sleepy, venerable NMDs turn out to be not so sleepy after all. Customarily, since their sensitivity to changes in market rates is low, their contribution to the increased interest expense brought about by a higher rate environment is, therefore, relatively low. If customers don’t act like they customarily have, a future defined by rising rates might motivate them to demand greater and more timely rate increases for their sleepy deposits. The insulation from earnings risk, which might appear to be the case today, may similarly turn out to be a mirage should actual depositor behavior deviate from convention. If your institution’s deposit growth has you or your regulator concerned about the effects of “too much of a good thing,” ad- justing the behavioral assumptions associated with the owners of those deposits can help give management a clearer picture of how things may play out if things don’t play out quite as expected. If you’re concerned that the rising tide of new deposits is also bring- ing in a rising tide of new risks, adjusting some of your modeling techniques may help uncover not only what’s at stake, but also what can be done about them. n Since 1979, we’ve helped our clients improve decision-mak- ing, manage interest rate risk, and maximize investment portfolio performance. Our proven approach of total resource integration utilizing software and products developed by Baker’s Software Solutions* — combined with our solid invest- ment experience and advice — makes us the investment firm of choice for many community financial institutions. For more information, contact Lester Murray at The Baker Group: 800-937-2257 www.GoBaker.com, or email: lester@GoBaker.com. *The Baker Group LP is the sole authorized distributor for the products and services developed and provided by The Baker Group Software Solutions, Inc. St. Albans / Buckhannon / Martinsburg, WV (866) 727-5501 www.chaptech.com Architecture + Interior Design Beckley Water Company Beckley, WV