Pub. 7 2016 Issue 2

www.wvbankers.org 8 West Virginia Banker A s instructive idioms go, “hope for the best but prepare for the worst” is a good one. While recognizing the human tendency for optimistic expectations, it acknowledges the practical contingency that an undesirable outcome may occur. It also exhorts us to be ready for it. For community bankers trying to prepare for a higher interest rate environment, the exercise of modeling the potential risks to earnings and capital is an attempt to do just that. By projecting the changes that happen to interest income and interest expense when the repricing of earning assets and paying liabilities occurs in higher rate scenarios, risk manag- ers can quantify the potential results a higher rate climate might produce. In a recently published Range of Practice Memoran- dum, results of surveys conducted by the Office of the Comp- troller of the Currency reveal only a small number of institutions reported elevated levels of interest rate risk. Quite naturally, the reported risk measurements were the surveyed banks’ modeling results, and that’s where hoping for the best collides with prepar- ing for the worst. The Past May Not be Prologue Regulatory authorities, aware that a variety of assumptive inputs are part and parcel of the interest rate risk measurement process, continue to remind us of their expectation that assumptions are reasonable, institution-specific, and supported by empirical evidence. Assumptions, however, despite the efforts expended and resources utilized in their genesis, are still assumptions; their accuracy never comes with a guarantee. In the context of the post-crisis business cycle and economic recovery process, and the manner in which these events and conditions differ from histori- cal patterns, even the reliability of time-tested causal relationships comes into question as a predictor of future behavior. Nowhere are these circumstances more relevant and the related assumptions more apt to be questioned than in the modeled por- trayal of those assumptions governing the behavior of non-ma- turing deposits (NMDs). So, despite the oftentimes-exhaustive How the Cow Ate the Cabbage: Are Your Interest Rate Risk Reports Giving You the Unvarnished Truth? By Lester F. Murray, The Baker Group LP