Pub. 9 2020 Issue 1

l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s 18 Fate Has Earned Its Reputation 2019 may best be remembered as the year when things that weren’t supposed to happen, happened anyway. The world’s major economies weren’t supposed to have spiraled downwards, but they did. Bond yields were not supposed to have fallen, but that’s what happens when growth decelerates. The Fed was not supposed to have reversed monetary policy and cut rates, but that happened, too. Three times. The presence of these conditions would be less significant were it not for the fact that most community banks had been readying their balance sheets for rising interest rates ever since the end of the Great Recession almost eleven years ago. And who could blame them? Since the beginning of the current growth cycle in mid-2009, regulatory authorities of all ilk have been loudly and repeatedly sounding the alarm of higher interest rates couched in their concern that this inexorable fate would harm earnings and impair capital. Risk, though, is a tricky thing. Its genesis does not typically spring from what is expected; rather, it comes from the unexpected things that sneak up on us. As a result, most community banks are very well prepared for rising rates, a condition that doesn’t exist, but less well prepared for low and falling rates; circa 2019. Preparing a bank’s risk profile for only one environmental condition is the perfect strategy to employ as long as one’s prescience is also perfect. But, managing interest rate risk and/or an investment portfolio should not be about outguessing the market. Nor should it be about trying to get ahead of the Fed or making bets based upon economic forecasts that are less reliable than astrological ones. What if a bank could make itself indifferent to interest rates? What if earnings projections could be made to be consistent across a wide spectrum of interest rate backgrounds? What if risk managers prepared their balance sheets for more than one outcome? Accomplishing these ideals sounds great as a concept, but in practice, very few institutions ever reach the promised land of interest rate indifference. One reason for this may just be the nature of human nature. Most people tend to think their beliefs and perceptions about the universe, including interest rates, are the correct ones. If they didn’t believe this, they would have different beliefs. Self-belief is a good thing, DON’T HITCH YOUR STRATEGY TO A RATE FORECAST By Lester Murray, The Baker Group