Published by CU Business
Despite the current conversations regarding rising interest rates and depositories’ bond portfolios, now is the time to look at long-term, sound asset liability management. Comments and questions such as “Rates went up and I should have locked in those gains” or “With the ten-year rising am I going to lose money on my investments?” should be the jumping off point to a deeper conversation about the fundamentals of banking and the overall impact of higher rates on financial institutions.
Focus on Your Core Functions
After all, if you had a crystal ball and knew the direction of interest rates BEFORE they moved, you would be the richest person on earth. The reality is that banks and credit unions run “funded” portfolios and should be less concerned with the direction of interest rates and more concerned with the level of interest rates. When interest rates go up, fixed rate asset prices do go down and that includes bonds, fixed income mutual funds, loans, etc. That is how present value math works. Of course, when interest rates increase, the value of the core deposit franchise moves in the opposite direction.
That is why sound asset liability management is so important to a bank or a credit union. Our clients and mutual fund investors are depositories first and mutual fund and bond investors second. Looking at a financial institution’s securities portfolio in a vacuum is not effective. Fundamentally, banking has its roots in the management (and ultimate success) of three main functions:
- Deposit gathering and the building of a deposit franchise.
- Lending, asset pricing and diversifying credit risk at a portfolio level.
- Liquidity, securities portfolio, and risk management.
For years, high performing financial institutions have not only perfected the management of these three functions, successful leaders have also understood how they work together as interest rates and markets ebb and flow. When interest rates move higher, credit costs generally move lower and deposit franchise values increase (in many cases the deposit franchise value is the largest driver of firm value and profitability). This makes higher rates a good thing for a bank or credit union, not a bad thing.