No. of Recommendations: 22
Some thoughts on banking. This might get a little detailed.
Rule #1: Banks are not in the business of interest rate risk! They are in the business of credit risk. Their goal is to manage interest rate risk to $0. However, this is impractical. Most balance sheets are either asset sensitive (assets reprice faster than liabilities) or liability sensitive (the opposite). Banks will have a range of tolerance (some percentage of net income). They use interest rates options and swaps to manage this risk down to a desired level. The is why rates can rise 300 basis points and Fannie Mae is not going under. They hedged their interest rate risk.
So SIGV making rate bets was totally inappropriate for a bank.
Banks measure and manage interest rate risk via a asset liability team. They have detailed contractual life's of most of all of the banks products at the customer level. They adjust these for accelerated prepayments or have to make assumptions when the contractual life is 1 day like a checking account. Most products however have contractual lives and banks model prepayment behavior so they can constantly make adjustments. These payment assumptions have to be constantly updated for changes in the overall level of interest rates.
I was in charge of the product assumptions for the transfer pricing system for First Interstate bank. I was also the CFO for the USC Credit Union. In something this small, I was also the "team" in charge of asset liability management. At USC, in our camel rating we got a 5 in asset liability management. This was about 10 years ago. The regulators told me that we were the only Credit Union they had ever given a 5 too. FYI, 5 is the best. My point is that many institution that you would think have great command of this issue, may not. It takes a combination of solid modeling and great understanding of consumer behavior. Most bank CEO's that I have worked with would not understand this information. They typically rise through the bank on the sales side. They may be a former commercial banker or head of the retail bank. They are networkers or handshake men or women. These are very different skills. Banks are complex financial organizations. When I worked at First Interstate 30 years ago, we had a balance sheet of $50 Billion. That is big. Bank are many times that size now.
I would reiterate. Growing a bank at a clip of greater than 15% a year is likely to have a bad outcome. You are likely to not have the sophistication for your new size and you may and likely will fund too many loans in a period that is not representative of an overall cycle. As the cycle progresses you will either have an outsized benefit or problem.
