Challenge your assumptions. The world is very different — or is it?
Remember the limbo dance contest? The aim was to pass forward under a low bar without falling or dislodging the bar. The bar was progressively lowered and therefore harder to get under at every pass. At some point a brave — and undoubtedly very flexible — soul would eventually snake their way underneath the bar that was just inches off the ground and win the contest.
At this point I could not tell you whether the analogy I am trying to make is about the self-preservation limbo where we find ourselves in because of this pandemic world, or whether it’s about the uncertainty causing that wobbly feeling of thinking you might just fall over, or whether it’s about interest rates and wondering, “How low can they go?”
Actually, I think I’m getting a three-for-one on the analogy front. Are we in limbo? It sure feels like it. I’m not sure I would call this dancing, but we certainly feel about ready to fall over. And while there was speculation a few months ago that interest rates could go negative, rates are certainly very low and are expected to stay there for quite some time.
I happened across a publication that the Federal Reserve wrote in 2013 on effective asset liability management (ALM), and in the first paragraph the author used a quote from a paper that was published in 2005. It started like this: “With growing cash balances and ever declining interest rates over the past several years, the banking industry’s net interest margins have trended downward….” Sound familiar?
We’ve all said it at some point in the last nine months: It’s like Ground Hog Day. Here it is 2021, and we are saying again what was said in 2013 and before that in 2005. One wonders just how many more times we can say it. It seems as if rates can’t go any lower — or can they?
Regardless, the insights from that paper are still very relevant today, even though the reasons for getting here are considerably different than in the past. As such, given the current economic conditions, you should once again seriously assess the assumptions you are using in your ALM modeling.
The challenges each financial institution faces in this pandemic world make one thing certain: Financial institutions can’t stay in limbo with regard to ALM. They must challenge the assumptions they are using and make sure they are relevant now and into the foreseeable future. No one knows exactly what is going to happen, but it’s worth taking a careful look to see whether cash flow projections seem accurate, whether interest rate assumptions and resulting depositor behavior have been assessed and adjusted and whether the impact of looming credit problems and loan deferrals have been anticipated.
While we have never been down this particular pandemic path before, we actually have responded to other financial crises in the past whose effects were very much the same.
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