Last month, we wrote about an impending rate cut. At that time, we wrote about what financial institutions – especially smaller institutions – should expect. A few days later, the Federal Reserve announced the first Fed rate cut for a decade. So now we have clarity – what can we learn?
Managing installments is a long-term game
The recent rate cut shows why IRR management needs a long-term strategy rather than the Fed's next step. Take into account the last 11 months of FOMC actions and forecasts as well as the market indicators. From September to December 2018, all signs indicated a further increase and the market was not worried about inflation. The Fed and the markets did not announce interest rate cuts for 2019 until March. By April, the Fed had forecast a rate cut in September. And here we are in August, getting ready for the first cut in a decade.
The moral of the story? It is not enough to simply react to the Fed and the market. Institutions acting on the basis of forecasts, measures and market activities in the past year will live with the consequences for a while – as we will examine below. Institutes that have a long-term strategy and clear insights into their performance are far better positioned to move beyond whatever the Fed and the market will do next.
Rate-exposed institutions may be burdened with higher capital costs
Tighter liquidity, competition for deposits and market indicators have increased the cost of capital. Many banks are faced with these higher costs as long as interest rates fall.
The liquidity of many institutions is becoming scarcer. Following the Great Recession, many institutions lagged with rising deposit rates, although Fed Funds Fed rates rose on account of deposit-intensive clients and low demand for credit. In mid-2018, however, demand for credit finally picked up. This reduced liquidity and triggered competition for deposits. Low-money institutions were only able to gain.
Banks that reacted too late to this liquidity crisis had to offer CD specials at higher rates in order to generate the required funds. Many institutes offered longer CDs at higher rates in order to protect against the future rate increases predicted at that time. Unfortunately, it turned out to be a trap. Banks that play CDs at higher rates face these higher costs.
How can financial institutions handle their interest rate risk?
Institutions can do things that help to make the transition. And deluxe can help.
Smooth your CD maturity ladder
These higher rate CDs will all mature at about the same time. Banker's Dashboard offers a powerful CD-schedule tool. This tool provides the ability to evenly distribute CD runtimes to avoid large fluctuations in the cost of capital at all times. A smoother CD maturity ladder allows banks to navigate the curve successfully.
Banks can renew some of these CDs at lower rates. The flat yield curve allows banks to extend CDs when maturing for longer maturities. or replace those specials with longer-term wholesale funds. This protects against future interest rate hikes if the economy warms up again.
Concentration on core deposits
Liquidity is at the heart of the problem. Core deposits should continue to be a priority.
The Banker Dashboard provides insight into the metrics that are most important to your performance. Users can set goals and track progress at a glance and in real time. Banks can also tell their employees how they can affect your net interest margin. Banker's dashboard supports this effort. The dashboard gives users performance details down to the level of each banker. In this way, FIs can hold lenders accountable for securing DDA accounts from credit customers.
Are you struggling with high interest rates and low liquidity? Contact us today and find out how Deluxe can help you.
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