We partnered with our friends Chris Cain at Carr, Riggs & Ingram CPAs and Advisors, Lance Holladay at Renasant Bank, and Chris Mihok at KBW to talk about hot-button issues facing banks in the year ahead. Keep reading for insights on maintaining margins and how asset-liability committees can best guide their organizations in these changing times.
In today's volatile economic climate, it is challenging for banks' asset-liability committees (ALCOs) and leaders to manage risks for future obligations. Even as interest rate hikes have slowed, we've seen recent bank collapses. Though rare, it signals just how important proper risk management can be as we move through 2023.
Since margin can represent up to 75% of an institution's total revenue, developing strategies to hold onto it will be important for institutions this year.
Here are a few steps institutions can take to maintain margins, as well as conversations that should be happening around ALCO tables in today's climate.
Managing Deposits, Debt and Tangible Common Equity (TCE)
In late 2022, the cost of deposits shot up throughout the country, and banks raised prices as a result. At the same time, though deposits increased significantly through the pandemic, there's still a significant gap in where they should be. And competition and lack of liquidity may make it challenging to increase deposits in the near future. Many banks also raised subordinated debt in the past few years and now have a revolving line they need to repay to maintain their capital.
All of these factors affect banks' Tangible Common Equity (TCE), which gives a broad picture of how well an institution can deal with potential losses. While it's not a regulatory measure, it can be a sign of stress that investors use to decide where to keep their deposits. ALCOs should address loss positions each quarter and plan ways to manage them moving forward to keep TCE at a healthy level.
Protecting the Core Customer Base
Losing customers is also a major concern ALCOs should be working to address. Many customers have less liquidity, whether due to inflation or maturing bonds, to make deposits and investments. Others are leaving the banking industry altogether and buying investments directly through the U.S. Treasury. There are several ways committees could adapt to keep the customer base they do have and attract new clients, including:
- Giving markets the option to use exception pricing as they see fit
- Running faster-yielding CDs to balance higher interest rates
- Developing special money market products to give investor's funds more liquidity
Balancing Strategies and Scenario Modeling
Banks need to keep in mind that they're not only competing with other banks – with current market uncertainty, credit unions, brokers and treasuries are all potential competitors. And keeping customers can have a big impact on margin. Although many banks have good sources of off-balance liquidity to lean on, it's still important to consider how different funding strategies and timeframes play into how much margin an organization can maintain. One key is to find the right mix between wholesale and retail clients and properly leverage each. For example, banks can remove some repricing risk by relying more on their wholesale business.
ALCOs should also look closely at scenarios to consider how each move impacts the institution from an asset-liability management perspective. Groups need to be ready to quickly adjust their models for a wide range of factors, many that we haven't seen in the past 15 years.
With these plans and projections, it's important to also remember that just because the dot plots show a certain result, it doesn't necessarily mean that's where rates and institutions are going. Things have changed a lot faster than anyone thought they would have in recent months, and it can continue to happen. At some point rates might pull back, but it's important to consider both rate-sound scenarios and the alternatives on both sides of the spectrum.
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