Interest Rate Risk

Article excerpt

Software that handles today's complex computations and simulations

One key element of community banking that doesn't outsource to third-party vendors well is interest-rate risk management. As loan and investment portfolios grow more complex, and as regulators get more demanding, independent community bankers increase their reliance on software to perform the sophisticated computations and simulations that make up today's interest-rate risk calculations.

The old practice of maturity gap management, born of the S&L crisis of the 1970s and the funding of long-term fixed-rate assets with floating-rate or short-term liabilities, has progressed to a more intricate analysis of repricing opportunities and their impact on total cash flow. Bankers today are expected to manage their net interest income proactively.

"Finally, we're learning that every bank needs a little science and that some scientific awareness of interest rate risk is absolutely essential for a community bank," says Art Gillis, technology consultant for banks and head of Computer Based Solutions Inc. in Dallas. "Bankers have been great historians but lousy prophets. The right software can be tremendously useful."

Buy a product that fits your mindset-one that you will be comfortable using-and base your decision on cost/benefit analysis, not price alone, Gillis advises.


IBAA Securities Corp., a wholly owned subsidiary of IBAA, offers two levels of interest-rate risk management software systems. The first level system is IBAA Securities' simulation model, which simulates income statements, balance sheets, performance measures and GAP reports. It uses linear regressed pricing and cash flow tables to project realistic earnings under an unlimited number of rate projections. The model sells for $5,000 to $8,000, depending on bank size. The price includes on-site installation by IBAA Securities CPAs.

The second level system is very easy to use and understand. It is the IBAA Securities Income Gap Model, which measures the primary interest rate risks defined by the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, including repricing risk, yield curve risk, basis risk and option risk.

This second model uses the pricing and cash flow algorithms from IBAA Securities' large simulation model to stress test earnings accurately under rising and falling rates. It was designed for those community banks with traditional balance sheets that do not need the power, nor the care and feeding, of complex simulation models. It is currently being used by more than 1,500 community banks to meet regulatory interest-rate risk measurement requirements and is provided on a complimentary basis to IBAA members.

For more information on the IBAA Securities family of interest-rate risk management tools, contact C.J. Pickering at (800) 422-6442, or fax him at (901) 762-5333.


Fortunately, software tools are available, scaled to community bank size, to help bankers do this job. One program specifically developed and priced for smaller banks is Interest Rate Risk Monitor from James Baker and Associates in Oklahoma City, Okla. The Windows-based product offers enough analytic power to satisfy the needs of the specialist to put it through its paces, the company says.

On the software's menu is gap analysis, net interest change analysis, market value of portfolio equity analysis and balance sheet effective duration and convexity measurements.

Customized simulations can be based on such factors as individual account sensitivity, bias, time lag, cash flows, decay rates or model-embedded options such as floating rate caps, collars and floors.

To make regulatory compliance easier, the James Baker program complies with FAS 107, which requires a fair value measurement of your entire balance sheet, and adheres to FDICIA 305, which requires capital adequate to withstand a sudden 200-basispoint shock. …