|6. Asset & Liability Committee|
|What you need to know||Join the meeting||Review the Reports||The board´s response|
|Monitoring Liquidity and
|Monitoring Bank Liquidity||Financial Modeling||Gap Analysis||Earnings at Risk (EAR) Models||Practice|
The negatively and positively gapped designations can be taken as indications of the relationship between changes in interest rates and in net interest income. For instance, a negatively gapped bank’s net interest income will move in the opposite direction of the change in interest rates. A positively gapped bank’s net interest income will move in the same direction as the change in interest rates.
Provided below are the liquidity summary ratios for Insights Bank and Trust.
Below is a Gap analysis worksheet for Bank A. Use the worksheet to answer the following:
Caption: Gap Analysis for Insights Bank
The ALCO recommends that the bank sell $1.6 million in Treasury notes coming due at the end of October and use the proceeds from the sale to buy higher-yielding, five-year notes issued by the Federal Home Loan Bank. The effect of this transaction would be to increase the bank’s negative gap–that is, the purchase would reduce rate-sensitive assets that will reprice within the next year by $1.6 million. The $1.6 million would now move to a 1-5 year time period column of the report. When the gap is recalculated, the bank’s negative cumulative gap position at one year would increase to $3,533. As a result, 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.
Below is the EAR report for Insights Bank and Trust. Use the report to answer the following:
What does the model forecast is likely to happen to earnings over the next year? Looking at the interest-rate projections, what do you think is causing this change?
The most likely scenario over the next year is that ROA will fall by 21 basis points or .21 percent. This is to be expected in an environment where long-term rates are falling and short-term rates are rising sharply, as the model predicts.
What seems suspicious about the projections here? As applies in other types of reports, look for changes in trends or time periods, discrepancies among the numbers or anything that might look unusual.
In this case, a quick scan shows a larger jump in the numbers between Q4 and Q5 for the three-month Treasury rate. The predicted three-month rate falls by 170 basis points in the fifth quarter. This would be a very unusual movement and very difficult to predict. Some bad assumptions may have been used in the model.
What is happening to the confidence interval on ROA over time? What does this tell you about the precision of the forecast?
The confidence interval is widening over time. This is a typical phenomenon because forecasts become less precise and reliable as the horizon extends into the future.
Remember, Earnings At Risk models provide forecasts based on assumptions about what will happen to interest rates and how the bank will respond. The best way to assess the output from such a model is to ask a lot of questions about the underlying assumptions and the level of confidence associated with the forecast. Though you will not be responsible for selecting or defending the assumptions surrounding an EAR model, you need to verify that the creators of these models have thoughtfully considered all of the underlying issues.
|<< Previous||Return to Meeting Agenda Page
(Main Page for the Course)
|Board's Response >>|