April 2000
Issue No.14
A/L BENCHMARKS
COMMUNICATOR
your monthly asset/liability management newsletter
Interest Rate Risk
Non-Maturity Deposit Decay Rates
Several bank core deposit accounts, such as DDA, NOW, Savings and MMDA do not have specific maturity dates.
This presents a special challenge when determining interest rate risk. The lack of contractual maturity dates makes
defining a cash flow forecast difficult. One widely accepted approach to solving this problem is to define core
deposit decay rates.
Using this approach DDA, Savings, NOW and MMDA accounts must be assigned a “decay factor.” Although
various methods for estimating core deposit decay have been used, most incorporate statistical analysis of historical
patterns. A/L Benchmarks uses the most recently proposed regulatory limits outlined below.
But what if these decay assumptions do not adequately represent your Bank? How can you determine more
appropriate decay rates? Jacque Kay of First Washington State Bank in Windsor, NJ uses a “liquidation”
approach, computing the average balance of total closed deposit accounts divided by the average balance of DDA’s
on a monthly basis. Initially this was a large project that documented the calculation for the previous five years.
Now it is updated quarterly and gives an accurate representation of the behavior of these accounts.
Looking forward, technology will offer bankers a greater depth of understanding of depositor behavior with the use
of data mining, expanded marketing data and customer loyalty statistics. Modeling practices may evolve to
incorporate these factors.
The myriad of options facing Bank consumers today makes their behavior less predictable than ever before. Yet
understanding the behavior of core deposits is crucial in interest rate risk management.
FFIEC Default Decay Rates:
Gap Buckets
< 3 Mths
3 – 12 Mths
1 – 5 Years
Total
Demand Deposits
17%
50%
33%
100%
Now & Savings Accounts
8%
25%
67%
100%
MMDA
17%
50%
33%
100%
Benchmark Briefs
Performance Scoring System
ORA is currently devising a scoring system that calculates and reports a quantitative score for your Bank’s
financial performance characteristics relative to Peer financial performance characteristics. The A/L Benchmarks
Scoring System has four goals:
• to reduce the amount of time for evaluating your Bank’s financial performance,
• to increase the level of understanding about your Bank’s financial performance,
• to ease the process of understanding bank financial performance, and
• to summarize comparisons of your Bank’s financial performance characteristics
with Peer performance characteristics.
Olson Research Associates, Inc
10290 Old Columbia Road, Columbia, MD 21046
Phone 410-290-6999, Fax: 410-290-6726, Email: [email protected]
April 2000
Issue No.14
Ask the Expert by Dr. Ronald L. Olson, Chairman ORA
Risk Based Capital too low?
Q. Our bank’s risk-based capital ratios seem low relative to the average of our Peer Group, yet our equity to
asset percentage is quite strong. Why?
A. Your “problem” seems to be one of asset allocation rather than quantity of capital. The risk weightings
applied to various assets primarily drive the risk-based capital ratio. Most loan portfolios, for example, require
100% risk weighting. Cash and US Treasury securities require 0% risk weighting. Other risk weighting
classifications are 20% and 50%.
In your bank’s case, you have a higher ratio of loans to assets than the average of the Peer Group and a higher
percentage of commercial loans within your loan portfolio. This all points to a higher average risk-weighted asset
position.
Additionally, within your securities portfolio, you have a higher than average mix of S&M revenue bonds.
Revenue bonds carry a 50% risk weighting factor and thereby increase your risk-weighted assets relative to capital.
Question: Do the revenue bonds produce a higher yield than alternative securities that may carry a 20% or 0% risk
weighting factor?
While your risk-based capital ratio is lower than the average for the Peer Group, keep in mind that Federal
Regulation has defined a well-capitalized bank as 10% total risk-based capital. Your ratio is still above 10% and is
not of concern unless you are forecasting a significant growth of loans without reassessing your asset allocation
policies. Since you have a high percentage of equity to total assets, be sure you are using your capital to its greatest
advantage.
Do you have a question for the expert?
Send it via email to [email protected] or fax it to 410-290-6726
or if you like, contact you’re A/L BENCHMARKS Analyst at (888) 657-6680
Welcome aboard
Upcoming workshops
The staff of Olson Research Associates, Inc.
extends a warm welcome to the following
A/L Benchmarks clients:
(CPE eligible)
Bank of Clarke County
Berryville, VA
May 11, 2000
“Getting the Maximum Benefit From A/L Benchmarks”
Columbia, Maryland
First NB of Port Allegany
Port Allegany, PA
The greatest compliment we can receive is a new
bank referral from one of our clients. Please
contact me if you have anyone who might benefit
from A/L Benchmarks.
Rose Valerio (888) 657-6680 ext.262
Email: [email protected]
May 12, 2000
“Revising Your ALCO Policies”
Columbia, Maryland
Cost per session $95.00
To register: Phone: (888) 657-6680 ext. 262 or
Email: [email protected]
Olson Research Associates, Inc
10290 Old Columbia Road, Columbia, MD 21046
Phone 410-290-6999, Fax: 410-290-6726, Email: [email protected]