During first-time ALCO conversations, institution leaders often ask us, “What am I missing?” And rightfully so; there is a lot to think about when managing the balance sheet. This decade has brought all-time low interest rates that transitioned into a historical rate shock, paired up with a bit of deposit volatility in between. Not an easy job to navigate, especially when managing interest rate fluctuations is near the top of the job requirement list.
What are you missing as we all look ahead to 2025 and continued earnings risk uncertainty? The curiosity is natural. A desire for a fresh perspective on balance sheet management is ubiquitous. But the real question becomes, when does curiosity ignite productive change in the ALCO process?
"Once the ALCO Finds Time"
The challenge is finding time. Starting a new project. Engaging the team to take an alternative path.
Besides, rates are changing, earnings may be challenged, budgets are tight, and most are doing more with less. Change can be uncomfortable. The value of time is at an all-time high.
But when is there ever free time? In fact, it is in times of uncertainty when risk (opportunity?) is greatest. Now is the time to test the status quo and take another view of proactive balance sheet management.
Here are four considerations to advance change in your ALCO process.
1) Change the Conversation
Acknowledge that the current status quo may be negatively affecting the ability to make strategic decisions.
I recently collaborated in a first-time ALCO strategy session for a new, high-performing client. I discovered that they were selling loans that they would otherwise add to their portfolio due to an archaic liquidity policy. A slight shift in perspective mixed with some advanced ALCO education actually uncovered a healthy liquidity profile, which drove the confidence to change course. Earnings went up while risk remained in balance.
2) Set Your Goals
Who knows what the second half of the decade will bring? We might very well be surprised by a calming of the markets. What is in your control is the ability to take a deep dive into who you are. Listen to what your balance sheet tells you. Use that knowledge as a proactive approach to understand your risks, and address those risks no matter what rate scenario comes next.
Identify the gap between where you are and where you want to be.
Get specific about what you want to accomplish. More strategic focus at ALCO? Data-driven decision-making? Lowering funding costs while driving growth? Addressing uncomfortable yet meaningful strategy opportunities (e.g., hedging)?
Identify key metrics on how to reach those goals.
3) Weigh the Outcomes
What if...
You save just one half of a basis point on total deposits…
You made strategic decisions independent of biases and based on what’s best for the institution…
You can make more confident decisions quickly and efficiently…
You make collaborative, interdepartmental decisions rather than in silos…
4) Lean into Independence
I recently had another first-time discussion with a management team that added swaps early in 2023 to hedge fixed rate assets and balance their risk profile. Well done. The risk position turned asset-sensitive. However, the institution doubled down on their swap position and subsequently doubled their exposure to falling rate risk, in addition to extending too far out on the curve. Our strategy discussion led to them paring back the swap position, which better aligned with the overall risk profile. Listening to the balance sheet and avoiding speculation is a tough balancing act when faced with such volatility.
A new year brings hope. Ahead of us is a new rate cycle. Political change. Regulatory reform. The fire is lit and in your hands. As we consider what 2025 might bring, we push the limits in this challenging industry and must ask, What are we missing? Now is the time to test the status quo and take a fresh view of proactive balance sheet management.
ABOUT THE AUTHOR
Joe Kennerson is a Managing Director at Darling Consulting Group. In this capacity, he works directly with financial institutions by providing solutions for their asset/liability management process in the areas of interest rate risk, liquidity risk management, ALM modeling, regulatory compliance, and executive-level education. He is a frequent speaker and author and directly advises clients in all aspects of ALM.
Contact Joe Kennerson at jkennerson@darlingconsulting.com or 978-499-8150 to work collectively to transform ALCO into a profit center.
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