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

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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.

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INSIGHT

Credit Enables Economic Growth

Fractional reserve banking enables credit provision essential for economic growth.
Returning to the gold standard or one-to-one banking would stifle growth by restricting credit availability.

INSIGHT

Treasury Manages Interest Risk

Treasury function manages bank's interest rate risk by pooling loans and deposits.
Internal fund transfer pricing rates adjust deposit and loan pricing to steer bank deposit gathering and lending.

INSIGHT

Balance Sheet Gap Creates Risk

Having long maturity assets funded by short maturity liabilities creates balance sheet gap risk.
This duration mismatch exposes banks to refinancing risk when rates rise.

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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