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April 2015


l e a d i n g

a d v o c a t e

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publication details in-depth the responsibilities

of Management and Directors in an Asset

Liability (A/L) process which results in effective

management of the bank. We traditionally have

viewed these reports and similar publications from the Federal

Reserve and OCC, as meaningful blueprints for what future

examination cycles could focus on. In this article, we focus on

Board and Asset Liability Committee (ALCO) responsibilities

outlined by the FDIC and recently published interest rate risk

metrics by the OCC.

Earnings Pressure and the Rate Forecast Backdrop

The stubbornly slow economic recovery was difficult to

diagnose early after the recession ended in 2009. The

corresponding prolonged period of very low interest rates has

confounded economic forecasters for the last five years. For

example, according to the Blue Chip Financial Forecast in

July 2009, expectations for the Fed Funds rate two years out

(2011) was a whopping 3.26%. Contrast that with Fed Fund

Futures currently trading around 1.25% - 1.75% in 2017.

This misdiagnosis early on in the recovery had the effect of

tamping down the willingness of many banks to extend 3-5

year fixed rate loans or add long term assets to the investment

portfolio – both common practices today. On the liability side,

depositors too have been unwilling to tie up funds beyond 12

months resulting in ballooning non-maturity deposit balances

across the industry. Persistently low rates and a slow growing

economy have led to an era of incremental lengthening of

assets, loosening of lending standards and short-term retail


Directors’ Responsibilities

With this backdrop, consider the oversight responsibilities the

FDIC outlines for Bank Directors. According to the FDIC,

“The usefulness of an IRR measurement system depends on the

reasonableness of the assumptions that are used as inputs” and

that the board of directors should complete a periodic review of

the key assumptions used in the modeling process. This review

is aligned with the ultimate responsibility the board has for the

degree of interest rate risk taken by the institution.

Active director involvement is cited by the FDIC as an

important component in the ALCO process at well-rated

institutions. Participating in discussions pertaining to policy

exceptions and key determinants of changing risk profiles are

noted in addition to discussing pricing strategies and product

mix with management in the ALCO meeting. On an annual

basis the board is responsible for assessment of the third party

review of the ALCO process. In short, it seems involvement

beyond cursory review of the current rate risk position and rate

environments is the responsibility of an effective Board.

Asset Liability Committee Responsibilities

The ALCO Committee has both oversight and strategic

responsibility. At the most basic level, ALCO needs to review

and approve the assumptions feeding the asset liability model

and understand the interest rate risk position of the institution.

In most cases this should occur quarterly but could be more

frequent in times of quickly moving market rates, emerging

competitive pressures or new product introductions. ALCO

should identify ways to mitigate risk and quantify the impact of

proposed strategies on interest rate risk, capital and projected

earnings. Upon review, it falls on ALCO to approve the

strategies for management to implement and review going

forward. Finally, ALCO has the responsibility to complete an

independent model validation and consider implementing any

recommended changes.

Growing regulatory attention on non-maturing deposit balances

places the responsibility on Banks to develop and maintain

pricing change betas and decay rates for these deposits.

Modeling potential migrating behavior of these balances going

forward should be analyzed by ALCO by completing change

in deposit mix simulations to determine potential liquidity and

earnings implications.

In the end, the A/L process is a key tool to manage interest rate

risk, an item the FDIC calls “one of the most important jobs of

a banker.” The process can be burdensome yet it’s incumbent

upon us as bankers to use this process not only for regulatory

compliance but also as the means to drive stable long-term

earnings of our institutions.

The BOK Financial - Financial Institutions Group provides third party asset

liability reviews, modeling, consulting, decay rate studies, and investment

portfolio strategy. Reach us at 866.440.6515 or

© 2015 BOSC, Inc. Securities offered by BOSC, Inc., member FINRA/SIPC.

Asset liability modeling, CD underwriting, portfolio accounting and safekeep-

ing services are provided by BOKF, NA, an affiliate of BOSC, Inc. Investments

and insurance are not insured by the FDIC; are not deposits or other obliga-

tions of, and are not guaranteed by, any bank or bank affiliate. The content in

this document is for informational and educational purposes only and does

not constitute legal, tax or investment advice. Always consult with a qualified

financial professional, accountant or lawyer for legal, tax and investment