Interest-Rate Risk: What Goes Down Must Come Up?

July 23, 2010
/ PRINT / ShareShare / Text Size +

What’s your risk exposure?

A strong asset/liability management (ALM) program can help credit unions position the previous question relevant to two others: How much risk does a credit union have to rising rates? And what’s the credit union’s strategy when interest rates do change?

It’s important to quantify how much risk a credit union has to changes in interest rates. But understanding how and why credit union-specific risk exposures are embedded in the balance sheet is just as important.

Without knowledge of these key issues, how can a credit union devise a sound strategy to address risk exposure and avoid undue pressure on earnings and capital? The answer: It can’t!

Most credit unions have seen their mortgage portfolios increase extensively over the past few years, and to a large extent they’ve funded this growth with relatively short-term funds (less than two years). The resulting long-term risk exposures have trended higher and higher. But why?

The answer becomes clear by evaluating the ALM reports or even the resulting weighted average lives (WAL) of assets versus funds. Growth in long-term assets (such as mortgages) that are funded with short-term deposits (such as one-year certificates) is causing a widening of the mismatch between the WAL of assets and liabilities.

As the mismatch increases, risk increases. The heightened risk exposures shown in a credit union’s net economic value analysis suggest long-term earnings and capital risk to rising interest rates.

When interest rates begin to rise, maturing deposits may need to be replaced at what will be higher prevailing interest rates, while long-maturity mortgages remain on the balance sheet at the older, lower interest rates. This mismatch creates pressure on earnings and capital: funding costs rise faster than asset yields, reducing gross spread, return on assets, and projected capital contributions.

By employing a sound risk management process, a credit union can monitor risk exposures and then enact a balance sheet strategy to ensure that interest rate risk doesn’t become overly burdensome and threaten earnings stability and capital adequacy.

Post a comment to this story


What's Popular

Popular Stories

Recent Discussion

Great article! Unfortunately, most employees don’t feel valued or appreciated by their supervisors or employers. In fact, research has shown that the predominant reason team members quit their jobs is because they don’t feel valued. This is in spite of the fact that employee recognition programs have proliferated in the workplace – over 90% of all organizations in the U.S. has some form of employee recognition activities in place. But most employee recognition programs are viewed with skepticism and cynicism – because they aren’t viewed as being genuine in their communication of appreciation. Getting the “employee of the month” award, receiving a certificate of recognition, or a “Way to go, team!” email just don’t get the job done. How do you communicate authentic appreciation? We have found people have different ways that they want to be shown appreciation, and if you don’t communicate in the language of appreciation important to them, you essentially “miss the mark”. Additionally, employees need to receive recognition more than once a year at their performance review. Otherwise, they view the praise as “going through the motions”. A third component of authentic appreciation is that the communication has to be about them personally – not the department, not their group, but something they did. Finally, they have to believe that you mean what you say. How you treat them has to match the words you use. If you are not sure how your team members want to be shown appreciation, the Motivating By Appreciation Inventory (www.appreciationatwork.com/assess) will identify the language of appreciation and specific actions preferred by each employee. You then can create a group profile for your team, so everyone knows how to encourage one another. Remember, employees want to know that they are valued for what they contribute to the success of the organization. And communicating authentic appreciation in the ways they desire it can make the difference between keeping your quality team members or having a negative work environment that everyone wants to leave. Paul White, Ph.D., is the co-author of The 5 Languages of Appreciation in the Workplace with Dr. Gary Chapman.

Your Say: Who should be Credit Union Magazine's 2014 CU Hero of the Year?

View Results Poll Archive