Will approval of the recommendation brought to the table by Madison to sell $1.6 million in U.S. Treasury notes and buy a like amount of Federal Home Loan Bank notes be in the best interest of the bank given an expected rise in interest rates?

Remember, earlier parts of the discussion on liquidity and market risk specify that it is the job of the Asset and Liabilities committee (ALCO) to:

How do your thoughts on the recommendation match up with those of your fellow board members at Insights Bank?

There was definitely a turn of events at the meeting. The outside directors, who were largely silent throughout the first part of the meeting, came forward with the analyses that should have accompanied Madison’s report from the ALCO. Bill Williams’ analysis about the bank’s liquidity position was right on target.

The bank, because of its loan growth, was becoming less liquid. Purchasing the five-year note would further reduce liquidity by replacing a liquid asset—the maturing U.S. Treasury note with a less liquid one. Similarly, George Titus hit the mark with his comments about the note purchase potentially increasing the bank’s exposure to rising interest rates. If rates rise as expected, the bank’s net interest income would decline more than if the notes had not been purchased. The recommendation to buy the notes is not a good one.

Madison isn’t trying to harm the bank, but her problem in this instance is that she is totally focused on the bottom-line performance of the bank—buying the higher yielding Home Loan Bank note would provide more interest income than the maturing Treasury note. She has forgotten that the bank has other needs as well. In this case, the bank has a growing need for liquidity. Also, it needs to manage possible exposure to rising interest rates.

Although you may never unveil a detailed analysis on the rest of the board the way George and Bill did, the analyses provided by your fellow outside directors at Insights Bank are instructive for a couple of reasons.

• First, receiving board meeting material ahead of time gives you time to think through matters being discussed and to develop ideas, solutions to problems and, in this case, analyses that aid in decision making.
• Second, as an outside director, you may not be an expert on banking, but you have the knowledge and skills that your bank needs to be successful. Be sure to contribute your ideas and thoughts and don’t be afraid to ask questions.

Lesson Objectives

After you complete this lesson, you should be able to:

• Point out the ways banks can use their balance sheets to manage their liquidity positions.
• Differentiate between investment securities classified as held-to-maturity and available-for sale (as a method for managing liquidity though assets).
• State the role played by a liquidity policy in helping a bank meet its obligations.
• Describe the objectives and the “who, what and when” of an investment policy.
• Recount federal agency guidance on the board’s role in managing bank market risk.
• List basic tools (policies and reports) banks use to manage their sensitivity to market risk.
• Spell out the importance of reports in market risk management and elements to look for in reports.