"Crisis-level" Asset Liability Management (ALM)-the old 'bucket' scenario-doesn't consider interest rate risk-adjusted returns and furthermore, can't make any money for a credit union, according to one person.
Instead, competitive CUs with complex balance sheets need measurement systems fueled for interest rate risk management practices.
That's according to Bob Burrell, chief information officer at WesCorp FCU, which provides balance sheet management, budgeting and profitability systems to its member CUs. WesCorp is the nation's largest corporate, with 981 member CUs representing 30% of U.S. credit union assets.
"We're seeing more credit unions move to interest rate risk management solutions," Burrell said. "The major benefit is getting to understand how the different components of the balance sheet interact and how that impacts the risk position of the credit union and future income streams. If a credit union understands what the alternatives are, it can make better decisions."
Risk-management technologies based in probability theories enable credit unions to weigh new products such as business lending and associated costs of entry, for example.
"As your balance sheet contains more mismatches and becomes more complicated, you need to break it down," Burrell continued. "You need to get information to make rational decisions, such as how to price products to members. The technology can help us consider the cost of each product on a risk-associated basis. So, we're taking out the mismatch on pricing for risk, and we're starting to look at the profitability of products."
WesCorp partnered with Chicago-based Quantitative Risk Management, Inc. (QRM) in 1995 to leverage the kind of consulting and technology that allows risk managers to analyze balance sheets at discrete points in time, but also to look at net interest income under varying interest, volume or maturity settings.
QRM captures the sources of interest rate risk and reports the effects of rate changes on the market value of capital and earnings using analytic models.
"We can model each piece of the balance sheet down to the individual transaction level," Burrell explained. "We can put in fixed income and algorithms to change those things over time. We build in inflation that changes expenses and revenues. In other words, we can take what's on the balance sheet today, take the strategic plan, and then see how the plan changes the balance sheet over time. We can model different strategic plans and see how that affects a credit union's position."
Interest rate risk management technology can become "an inherent part of managing business" for any size CU with a complex balance sheet, Burrell added. CUs with assets from $15-million outsource risk management with Wescorp.
The risk-associated trend in ALM isn't just a good idea for expanded vision and profitability-changes on the regulatory front are also spurring the movement. The Basel Committee on Banking Supervision on behalf of the Bank for International Settlements is making a splash in the industry with the newly postponed Basel Accord on Capital Adequacy (Basel II) and its new ALM rules, the Principles for the Management and Supervision of Interest Rate Risk.
