Managing financial risk models amid tariff uncertainty
Tariffs, or the mere threat of tariffs, have led to significant market volatility and uncertainty. The potential for a recession is being mentioned more often in the news. Business and consumer sentiment is trending lower. The VIX index, often called the “fear gauge,” has seen spikes as tariff announcements hit the headlines. For institutions, this uncertainty creates additional challenges in liquidity and interest rate risk (IRR) model assumptions.
Steps to incorporate tariff impacts into your risk modeling
Institutions can take specific steps to incorporate tariff impacts into their liquidity stress testing scenarios and IRR model assumptions:
1. Identify key tariff-related risks
Review and understand how tariffs might affect the institution’s loan portfolio. This includes analyzing loan concentration in sectors that are sensitive to trade policies, like agriculture and retail (including the restaurant sector). Evaluate the creditworthiness of borrowers in these sectors. Consider factors such as their reliance on imported goods, their ability to pass on cost increases to customers and their overall financial health.
On the liability side of the balance sheet, consider potential deposit behaviors. Should an influx of non-core deposits should be on your radar? As many investors search for “serenity now,” they may temporarily park a portion of funds in deposit accounts. How might that impact your uninsured deposit levels?
2. Liquidity stress testing
Develop stress testing scenarios that incorporate potential tariff impacts. Evaluate the institution’s liquidity position under scenarios where tariffs could lead to economic downturns. Assess the impact on cash flows, funding sources and the ability to meet obligations.
Will there be deposit surges and subsequent outflows to closely monitor? Include key liquidity metrics such as cash flow projections, loan-to-deposit ratios and liquidity coverage ratios under different tariff scenarios. These scenarios should vary in severity to evaluate the resilience of the institution’s liquidity in both mild and severe conditions.
3. Adjust IRR assumptions
Modify assumptions in your IRR models, especially the models incorporating a dynamic or strategy balance sheet, to reflect potential changes in interest rates and economic conditions due to tariffs. This includes considering the impact on loan demand, deposit growth and interest rate spreads.
Additionally, would there be a shift in the types of loans demanded? For instance, businesses might seek more working capital loans to manage cash flow disruptions caused by tariffs. You may need to adjust your models to reflect changes in the composition of loan demand and credit quality. Your loan review process should incorporate tariff sensitivity assessments for CRE borrowers, particularly watching for signs of tenant stress in retail and warehouse properties.
4. Regular monitoring and updates
Continuously monitor economic developments and trade policy changes (some days they change by the hour). Regularly update models and scenarios based on new data and insights. This should include watching your early warning indicators, like shifts in customer behavior. For example, increasing the use of lines of credit among trade-dependent borrowers could signal cash flow stress requiring closer monitoring.
By integrating these steps, institutions can incorporate tariff impacts into their model assumptions and liquidity stress testing scenarios, enhancing their ability to navigate economic uncertainties.
How Wipfli can help
Wipfli’s financial services team can help you adjust your risk management approach. Contact us to discuss how we can help your financial institution prepare for the changing trade landscape, and stay up to date with our policy and tax updates page.
