The Education of a Value Investor

Asset Liability Management & Interest Rate Risk in the Banking Book - Part 3 of 4

Nov 22, 2024

Eric Schaanning, an expert in asset liability management, joins Guy Spier to explore the intricacies of interest rate risk in banking. They discuss how interest rate fluctuations can significantly alter customer preferences, impacting deposit behaviors. Schaanning highlights the importance of behavioral modeling in assessing credit risk, revealing that changes in spending habits can signal financial distress. The conversation culminates with a shocking reminder that fixed-rate loans may turn perilous amid unexpected interest spikes, setting the stage for essential risk management strategies.

56:40

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Episode guests

Eric Schaanning

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Podcast summary created with Snipd AI

Quick takeaways

Banks must adeptly forecast customer deposit behaviors amid fluctuating interest rates to manage liquidity risk effectively.

Interest rate changes significantly affect net interest income and economic value of equity, emphasizing the need for robust risk management strategies.

Deep dives

Understanding Basel Frameworks and Their Impact on Risk Management

The Basel Committee on Banking Supervision (BCBS) was established to respond to international banking crises, particularly after the failure of Herstatt Bank. Over the years, the Basel Accords (Basel I, II, and III) have evolved to introduce more sophisticated risk management strategies and minimum capital requirements for banks, addressing issues like liquidity risk. Basel I set a foundational capital requirement, while Basel II introduced a three-pillar framework that emphasized risk measurement and supervision. The ongoing development of Basel III seeks to enhance these regulations, particularly against the backdrop of financial crises that highlight the shortcomings of previous frameworks in handling liquidity risk.

Intro

4min

Banking Complexities and Economic Growth

7min

Understanding Net Interest Income and Rate Risks

9min

Understanding NII and EVE Indicators

4min

Navigating Interest Rate Risks in Banking

16min

Managing Cash Flows and Liquidity Risks

9min

Understanding Cash Flow Management and Customer Risk Assessment in Banking

2min

Understanding Credit Risk and Interest Rate Challenges in Banking

5min

In this gripping segment, Eric Schaanning and Guy Spier delve into the complex world of interest rate risk, revealing how seemingly straightforward banking practices can quickly turn into high-stakes dilemmas. Schaanning breaks down how banks forecast deposit behaviours, merging historical trends with expert judgment. He explains that as interest rates fluctuate, customer preferences shift dramatically—rising rates lure them into term deposits for better returns, while declining rates send them back to the safety of site deposits.

But the intrigue doesn’t stop there. The duo uncovers the hidden layers of behavioural modelling in assessing credit risk, identifying subtle signals that may indicate a customer’s financial distress. Changes in spending habits and payment timing can serve as critical warning signs, shedding light on the delicate balance banks must maintain to safeguard their portfolios. Spier interjects with essential advice for individuals grappling with financial strain, emphasizing the power of communication and proactive payment management.

As the conversation reaches its climax, Schaanning reveals a shocking twist: a seemingly lucrative fixed-rate loan could morph into a devastating loss due to unexpected interest rate spikes. With banks grappling to adapt in an ever-shifting economic landscape, the stakes are higher than ever. This tantalizing cliffhanger sets the stage for their next discussion, where risk management strategies and survival tactics will be put to the test in the face of looming financial uncertainties.

Full transcript available here: https://aqfd.docsend.com/view/jtbtn9zjhaebq9eh

Here's a link to the presentation: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5007032

Contents:

(00:00:00) Why banking Regulations Matter: A Dinner Table Explanation

(00:08:50) Calculating Net Interest Income with a Simple Example

(00:14:22) Fixed vs. Floating Rate Loans: Cash Flow Dynamics

(00:22:19) Balance Sheet Management: Shifting Between Income and Capital

(00:29:47) Interest Rate Swaps and Market Liquidity

(00:37:57) Exploring Risk Measurement and Gap Profiles in Banking

(00:40:52) Navigating Liquidity Risk and Redemption Dynamics in Investment Funds

(00:48:24) Understanding Interest Rate Risk and Behavioural Modelling in Banking

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The Education of a Value Investor

Asset Liability Management & Interest Rate Risk in the Banking Book - Part 3 of 4

Episode guests

Podcast summary created with Snipd AI

Quick takeaways

Deep dives

Understanding Basel Frameworks and Their Impact on Risk Management

The Role of Interest Rates in Economic Growth and Banking Stability

Net Interest Income (NII) and Economic Value of Equity (EVE) Calculations

Assessing Interest Rate Risk Through Balance Sheet Management

Remember Everything You Learn from Podcasts