How to Model Non-Maturity Deposit Accounts (NMDAs)?
Hi. I am Howard Lothrop host of Echo Partners TV. Today we're going to talk about the single area in interest rate risk measurement and modeling that is is more responsible for greater swings and therefore most important for you to get right with your assumptions. Do you know what that is?
It's how you handle your non-maturity deposit accounts. Non-maturity deposit accounts as the name implies, are those deposit accounts that do not have a stated maturity. These would be things like our transaction accounts our checking and savings and our money markets.
You get the idea. Anything that does not have a stated final maturity. Now there a number ways we can model these everything from overnight to a multi-year average life and so simply by changing the model assumptions with respect to non-maturity deposit accounts we can make any bank more or less rate-sensitive or at least reported as more or less rate-sensitive simply by moving those account assumptions.
Because these assumptions are so powerful you must focus your attention on getting this one right. So how do we go ahead and and come up with these model assumptions? Well, there are four main ways to model your non-maturity deposit accounts.
The first way is to go with the contractual or stated legal term, which is overnight. After all these depositors can come in the bank tomorrow withdraw all their funds and go. The good aspect of this sort of the assumption is that it's easy and it's technically correct. The downside however is it's not accurate in the least. This is not how these deposit accounts actually behave and if you do put your nonmaturity deposits in the overnight bucket you are going to be understating the banks asset sensitivity.
The second way that you can handle creating these nonmaturity deposit assumptions is to engage a consultant and do a deposit study. The deposit study looks at historical data on rate movements and how these deposit balances have varied in various rate scenarios, such as up, down or stable and determines the average life and sensitivity to rate moves. The benefit of this type of study is it is highly accurate as it's based on historical data at your bank. The downside is that it's an expensive process and it's tough for a community bank to justify spending five figures for a deposit study.
The third way we can come up with nonmaturity deposit assumptions might be almost as accurate as a deposit study itself. And that is to convene a group of the bank's top management team and use your experience at the bank. We always want to use bank specific information where we can. Use your anecdotale recollections and your qualitative understanding of how these accounts work. How do you recall accounts moving with respect to to rate movements and with pricing decisions?
Now the good news here is you can get a very accurate sense of your nonmaturity deposits average lives and sensitivity. The downside to this approach is that there is not much regulatory backup. So when your examiner comes in for your interest rate risk exam and start asking about your your assumptions you really don't have much in the way of backup materials to give that examiner and and we all know examiners like to see some backup for assumptions, particularly big powerful assumptions like this.
Well what we do, what we often suggest to community banks is to go with the fourth approach. The fourth approach is to use the regulators safe harbor.
When FIDICIA was passed it had a plethora of the aspects related to interest rate risk. One of them was the notion that the regulatory community should come up with a industrywide asset liability model that they would subject all FDIC insured financial institutions to. In this way they would have some consistent method of examining interest rate risk among various insured depositories.
So for a multi-year period there was a series of proposed regulations, comment periods and revisions. We got well down the regulatory rulemaking path prior to the regulators abandoning the approach and deeming it somewhat unworkable as a one-size-fits-all.
However, prior to abandoning this approach, the regulators published in the Federal Register their safe harbor of assumptions for maximum average lives for all of these types of accounts. So here's is what we do is we've done some digging.
We've uncovered the chart from the Federal Register. And we as a default starting point for a community bank set of assumptions use these nonmaturity deposit accounts and the regulatory safe harbor.
This has two main benefits. Number 1 it allows us to to document a multi-year average life for these accounts, which is generally speaking accurately reflecting the way the accounts actually behave. The second benefit of using this approach is a piece of paper in the file so that when the examiner comes by you've got something to pull out that says Hey guess what you know OCC FDIC you've all signed off on this.
So that's the approach that we suggest community banks take if they do not have other bank specific information. Once again, if you have situations or circumstances at your bank that are different or cause your deposits to have a shorter average life you must as a manager shorten those average lives and use those bank specific numbers.
While I hope you got something out of this today and we look forward to seeing you on the next episode.