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Echo Partners Community Bank Blog

    Why Your Regulator Wants a Deposit Study and How You Know

    [fa icon="clock-o"]} [fa icon="user"] Howard Lothrop [fa icon="folder-open'] deposit study

    There are really only 2 kinds of banks right now...those the regulators have already told to get a deposit study and those they are going to tell to get a deposit study soon. 
     
     
     
    Here's what they want you to do:
    1) Produce statistically significant quantitative studies that calculate your bank's specific demonstrated deposit behaviors.
    2) Adjust these numerical results for qualitative factors such as surge deposits.
    3) Document your results in a way that fully supports these most important IRR assumptions.
     
    Here's why they are concerned: 
    Time deposits are at a 15 yr low while NMDAs are at a 15yr high.  They believe when rates turn these relationships could well reverse.  I've attached an FDIC graph below on these deposit trends.
    FDICDeposittrends
     
    OCC specifically has called out banks on the need to calculate, produce, and document bank specific assumptions, particularly deposit assumptions.  Here are a few references.
     
    FAQs on Interest Rate Risk Management
    http://www.occ.gov/news-issuances/bulletins/2012/bulletin-2012-5a.pdf
     
    The final 2 questions (on page 10) are the only questions related to assumptions and both refer to NMDA assumptions.  I've replicated them below...
     
    Assumptions
    11. Can an institution use industry estimates for non-maturity-deposit (NMD) decay
    rates?
    Answer: Institutions should use assumptions that reflect the institution’s profile and
    activities and generally avoid reliance on industry estimates or default vendor assumptions.
    Some institutions, however, have difficultly measuring decay rates on NMDs because of
    limitations on their systems’ ability to provide necessary data, acquisitions or mergers, or
    possibly a lack of technical expertise. Industry averages provide an approximation but may
    not be a suitable estimate in every case. For example, customer types and behaviors are
    inconsistent across geographic areas and are likely to produce very different deposit decay
    rates from one institution to another. Industry estimates should be a starting point until
    sufficient internal data sets can be developed. An institution can contract with an outside
    vendor to assist with this process if necessary. For any key assumptions, back-testing
    should be performed to determine whether assumption estimates are reasonable.


    12. Regarding deposit decay-rate assumptions, what are some examples of a “market
    environment in which customer behaviors may not reflect long-term economic
    fundamentals?”
    Answer: Management should carefully consider deposit and NMD decay-rate assumptions,
    particularly when customer behaviors change during periods of stress as well as external
    factors that may influence that behavior. For example, customers’ flight to quality (insured
    deposits) during times of stress might influence NMD decay rates. Additionally, the
    deterrence value of prepayment penalties during times of near-zero interest rates (penalty
    becomes negligible) might influence time-deposit decay rates. Similar considerations
    should be given to other key rate drivers and prepayment assumptions used in the IRR
    model.

     
    Even more recently, the OCC Semiannual Risk Perspective Fall 2014 hits these points again.  Here's the link:
    http://www.occ.gov/publications/publications-by-type/other-publications-reports/semiannual-risk-perspective/semiannual-risk-perspective-fall-2014.pdf
     
    Pages 34 - 37 concern IRR and say...
     
    Bottom of page 34:
    "The IRR data show a wide range of practice for NMD assumptions. The diversity of the data indicates
    unique funding profiles and stressors, and different customer types and behaviors across geographies
    and depositor balances. NMD deposit assumptions are a key component of IRR measurements and a
    driver of earnings and economic capital exposures. Accordingly, it is important that banks not rely on
    external proxies and instead use assumptions that reflect the bank’s unique profile in order to identify
    risk properly."

     
    Middle of page 35:
    "Banks reported a wide range of expected NMD
    repricing assumptions for a 100 bp change in interest rates (see figure 29). For example, the median
    money market deposit account (MMDA) repricing rate was 40 percent. This indicates that for an
    increase in interest rates of 100 bps, the majority of banks expect MMDAs to reprice upward 40 bps.
    Repricing assumptions, especially in MMDA-related accounts, vary widely, and should be analyzed
    carefully to ensure the sensitivity estimates appropriately reflect realistic expectations.
    "
     
    Lower half of Page 36:
    "Banks reported expected decay assumptions for six different deposit categories. The decay rate
    estimates the percentage of an account that will “run-off” or move out of a particular deposit product
    for a given rate change. The decay rates reported by banks are, like the banks' reported repricing rates,
    contingent on multiple factors. Deposits that are more volatile (e.g., MMDA and High Yield MMDA),
    show higher decay rates than more stable savings accounts (see figure 31). Banks reported expected
    decay rates over the full range of possibilities (to 100 percent decay) for MMDA accounts. The OCC
    did not collect data indicating whether the decay volume leaves the banks or moves into different
    deposit categories as a part of this analysis. The wide range of decay rate assumptions should be
    analyzed carefully to ensure the sensitivity estimates appropriately reflect realistic expectations.
    "
     
    Final paragraph on Page 37:
    "Outliers in reported exposures and NMD assumptions may indicate diversity in balance sheet profiles
    or unrealistic or incorrect modeling assumptions. The OCC reminds banks of the need to perform
    sensitivity analysis of NMD assumptions to identify the potential impact of depositor instability.
    Testing the sensitivity of existing assumptions by applying subtle or significant variations to the
    repricing or decay rates may be used to analyze the potential impact on capital and earnings if
    depositors are less stable, or more price sensitive, than expected
    "
     
     
     
    Please let me know if you have any questions.  Thanks.
     
    Howard
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    Howard Lothrop

    Written by Howard Lothrop

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