Banks should re-assess deposit risk models amid Covid-19

28 July 2020 5 min. read

The outbreak of the corona crisis is changing financial behavior of businesses and consumers. This is in turn having a significant consequence on the way banks oversee their deposit portfolios and the risks involved with them. 

According to experts at financial consulting firm Zanders, banks should now re-assess the models they have in place to measure and manage deposit interest rate risk. There are two main reasons for this. First, across the board, spending is being curbed while savings are on the up, meaning that new inflows are rising. The reason: in times of economic uncertainty, retail and wholesale clients of banks shift into a more conservative mode.

A survey of asset-liability management (ALM), risk and treasury managers of Western European banks by Zanders found that slightly more than half of the banks are currently observing a net inflow as a result of the Covid-19 virus. Adding to the net inflow volume is the fact that in most Western European countries government support is being paid out, which lifts the current account balances of businesses that receive such support.

What impact from Covid-19 do you observe on deposit inflows or outflows?

Second, the sentiment is touted to turn in the coming months, and from September onwards (when most government support schemes are phased out), banks are expected to increasingly experience distressed customers. To anticipate timely on the development, interest rate risks and liquidity risks on deposits should be placed under the lens, and lines of defence need to be sharpened, said the authors of the report Martijn Wycisk, René Andersen and Geert Jan den Hertog. 

More than two-thirds of respondents to Zanders’ survey said that they plan to revisit the current behavioural deposit model in place or apply an override to model outcomes to reflect the impact of Covid-19. The majority of respondents plan to re-assess current assumptions and refine scenario analysis (76% and 64% respectively). Around a quarter of them, 24% and 32%, respectively, indicated their focus is on making adjustments in the replicating portfolio and on monitoring and back-testing activities. 

The authors warn that if banks don’t conduct an analysis and take needed actions, they risk facing a number of adverse effects, such as inaccurate hedges, increased liquidity risk and misreporting of IRRBB metrics.

Do you consider updating or recalibrating your current (behavioral) deposit model?

Based on their findings, the experts have drafted four recommendations for finance, risk and treasury managers:

Redefine new (baseline) scenarios

As current economic outlooks are highly uncertain, so-called V-shaped, U-shaped, W-shaped and L-shaped scenarios are considered in the industry, each assuming different paces and evolvement of economic recovery. Banks can assess the development in markets rates and balance sheet development for each of the scenarios. 

ALM and risk managers should redefine and update market rate, client rate and deposit volume development (forecasts) depending on the economic outlook scenarios. Banks’ behavioural models should be updated to apply new baseline and (at-risk) scenarios.

Apply behavioural overwrites

Models calibrated on historical data are decreasingly representative for estimation of future behaviour, as there is yet limited data available on deposit behaviour in crisis times like the current one. Therefore, banks’ ALM and risk managers should reassess all relevant behavioural model assumptions and rely on expert judgement to define overwrites on client rate and volume forecast, the (non-)core portion and term-out.

What model aspects do you find most important in these stressed times?

Intervene in replication rollover (ad-hoc)

Material imbalances in replicating portfolios can occur when non-core and core deposit portions change. When current non-core portions are maintained and volatile deposit volume increases, volume inflows (non-core) will be gradually replicated into longer-term tenors over time. 

Banks are therefore advised to ring-fence deposit inflows in short-term replication tenors. When experiencing material outflows, replicating portfolios should be rebalanced more frequently. To prevent structural replication imbalances and overwrites, banks are recommended to recalibrate their replicating portfolio models. 

Strictly monitor deposit volume development

Because Covid-19 hit Western Europe’s economies only a couple of months ago, there is no transparency on the implications of (inaccurate) behavioural assumptions during crisis times and there is no trigger yet to review behavioural models. It is recommended to monitor deposit inflow and outflow on a daily basis and assess the deviations of observations with respect to predictions. Imminent deviation from modelled outflows could trigger rebalancing, and material deviations result in (more frequent) recalibration of (behavioural) deposit models.