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Shifting depositor behavior warrants rethinking of ALM models

Apr 24, 2023
By: Luke Soper

I talk to bankers every day about their asset/liability models, and when I ask about non-maturity deposit (NMD) assumptions, everyone tells me the same thing, “Our customers have been with us for years. Our deposits are long-term, stable, core funding.”

While I understand that outlook, it may be time to rethink it. Technology, higher interest rates and recent market events are shifting depositor behaviors, and financial institutions need to adjust their asset and liability management (ALM) models to reflect the changes.

Institutions assign average lives to the NMDs in their ALM model. Since depositors can withdraw their funds at any time, the institutions are estimating the cash flows of the deposits. The average life of a deposit is the weighted average time expected for repayment of the principal. The timing of those cash flows impacts the institution’s interest rate sensitivity.

When setting NMD assumptions, members of an asset/liability committee (ALCO) should be aware of several recent developments in their decision-making.

Recent market volatility has given consumers and businesses a reason to look more closely at their accounts. Failures at several large banks have reminded depositors about the importance of the Federal Deposit Insurance Corporation and National Credit Union Administration insurance limits. In the face of calls to expand guarantees on deposits beyond the current $250,000 limit, Treasury Secretary Janet Yellen recently said that the administration was not considering this measure.

Higher interest rates have also triggered various consumer behaviors as they pay more attention to their options. Consumers are seeing higher deposit rates for the first time in years. Over the last 60 days alone, the average national money market rate is up 10 basis points. On top of that, social media is full of talk about TreasuryDirect rates, the best money market accounts and other deposit specials.

Technology has made it easy to transfer balances instantly without setting foot in a branch. Digital banking applications mean that customers can withdraw funds with the click of a button. After the Silicon Valley Bank failure, $174.5 billion, or approximately 1% of all deposits in commercial banks, left the banking system in a matter of days.

It’s time to consider how these developments impact the financial institutions’ interest rate risk. These steps can help management reduce risk:

  • Understand and document support for NMD average lives in the ALM model. Best practice is to use an institution-specific historical study.
  • It is critical to adjust model inputs based on expectations. Management should consider flight to quality, rate differentials, technology, demographics and competition.
  • Periodically compare average lives to the Office of the Comptroller of the Currency interest rate statistics report to understand where the inputs stack up. As of the fall of 2022, the median average lives of NMDs for all reported banks were 3.54 years for money market deposit accounts, 4.50 for interest checking, 5.00 for savings and 5.00 for non-interest-bearing checking.
  • Consider whether a portion of the institution’s balances are “surge,” or deposits that could rapidly migrate to other non-bank investments or higher-yielding products. Given the rise in COVID-19-related deposits, management could segregate the ALM model categories between surge deposits and more stable core deposits.
  • Mitigate model risk by running sensitivity tests on NMD assumptions. Typical tests include shortening the average lives of deposits, as well as increasing the balance of surge deposits. Management should run one stress at a time to isolate the impact of the stressor.

How Wipfli can help

Now’s the time to dig into these critical model inputs to assess and mitigate risk. Wipfli specialists can provide your institution with a comprehensive overview of your financial institution’s ALM process. You’ll have access to a team of consultants experienced with all aspects of ALM who can help you navigate through challenges related to changing interest rates and economic conditions.

Contact us to learn more about our ALM services.

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Luke Soper, CPA
Senior Consultant
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