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Deposit Pricing Lags As Rates Rise

February 15, 2011

Many financial institutions see an eventual rise in market rates as an opportunity to create greater margin between what they pay on their non-maturity deposits and what they can yield on their new and or variable-rate assets.  This idea is not new.  However, what is different is that many credit unions are building into their model assumptions an ability to lag their deposit pricing increases MORE than what they had actually done in previous environments when rates were on the rise.

A common rationale for this kind of assumption change is based on the fact that many financial institutions are sitting on excess liquidity, have reduced capital ratios and have struggled with earnings in recent years.  Some credit unions feel like there will not be a need or appetite to raise rates as far and as fast as in prior periods.  This could very well be true.  However, should credit unions base their assumptions on the actual history of rates that were paid?  Or, should they use more optimistic assumptions that may or may not ever materialize?  After all, what’s driving up rates could be as important in its effect on deposit pricing as the relative health of financial institutions.  Changing key assumptions in risk simulations should be considered very carefully.  If institutions lower deposit pricing assumptions, it would be a good idea to test and document the impact, and be cautious about making decisions to add risk because there is now “more room” thanks to that assumption change.

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