Savings modelling series – How ‘hidden savings’ impact the risk profile for banks
Low interest rates, decreasing margins and regulatory pressure: banks are faced with a variety of challenges regarding non-maturing deposits. Accurate and robust models for non-maturing deposits are more important than ever. These complex models depend largely on a number of modelling choices. In the savings modelling series, Zanders lays out the main modelling choices, based on our experience at a variety of Tier 1, 2 and 3 banks.
WHAT ARE HIDDEN SAVINGS?
Because the low or zero rates offered by banks provide little motivation to move money to savings accounts, many banking customers use their current accounts as savings account. It is very likely that customers will move part of this money to savings accounts when rates increase again. This ‘hidden savings’ or ‘savings substitution’ volume and savings accounts volume have the same interest rate sensitivity, including the asymmetric ‘flooring’ effect.
SO, HOW DO I DEAL WITH THEM?
Given the existence of these hidden savings, it might be justified to model it with a shorter maturity, thereby increasing funding stability. Because hidden savings proves to be very difficult to quantify and substantiate in practice, its modeling is still not general practice with Risk and ALM managers. The banks that do include the hidden savings effect typically use historical data-based approaches, combined with expert-based guidelines on the measurement approach and significance thresholds. Significance thresholds can be relative (a fixed percentage of total current accounts volume) or absolute amounts (for example 100 million euro of volume).
"Because the low or zero rates offered by banks provide little motivation to move money to savings accounts, many banking customers use their current accounts as savings account."
USING HISTORICAL DATA
Some banks use historical portfolio data to estimate the hidden savings portion of current accounts. Hidden savings is defined as the portion of volume after subtracting the volatile and long-term volume. The volatile (non-stable) volume is estimated based on intra-month (daily) volume fluctuations. The long-term, non-repricing, volume (core volume) can be estimated based on historical minimum volume levels.
Another measurement approach is to use account-level data to estimate the hidden savings volume. The average current account balance development over time is used to identify a trend of accelerating balance levels. Hidden savings is derived as the portion of current account volume above historically identified trends. To identify these historical trends, sufficient historical data on time periods with a significant difference between savings and current accounts rates are required.
SAVINGS MODELLING SERIES
This short article is part of the Savings Modelling Series, a series of articles covering five hot topics in NMD for banking risk management. The other articles in this series are:
Savings modelling series: Non-maturing deposits model concepts
Low interest rates, decreasing margins and regulatory pressure: banks are faced with a variety of challenges regarding non-maturing deposits. Accurate and robust models for non-maturing deposits are more important than ever. These complex models depend largely on a number of modelling choices. In the savings modelling series, Zanders lays out the main modelling choices, based on our experience at a variety of Tier 1, 2 and 3 banks.
Are you interested in a more in-depth comparison of deposit modeling concepts? Click here.
For banks with significant non-maturing deposits portfolios, Risk Management functions need to have a robust behavioural risk model. This model is required for Interest Rate Risk in the Banking Book reporting, hedge, stress testing, risk transfer, and ad-hoc analyses. Although specific modelling assumptions vary per bank, cashflow-based models, a replicating portfolio model, or a hybrid model are market practice model concepts. The choice for one of these models is strongly linked to model purpose and use. Each concept has its benefits and drawbacks for different purposes and uses.
CASHFLOW-BASED MODELS
Cashflow-based models consist of two sub-models for the deposit rate and volume that forecast coupon and notional cashflows, respectively. Both sub-models measure the relationship between behavioural risk and underlying explanatory factors. Cashflow-based models are suited to include asymmetric pricing effects (such as flooring of rates) in resulting risk metrics. Since the approach captures rate and volume dynamics well, it is also often used for ad-hoc behavioural risk analysis and stress testing.
"The choice for one of these models is strongly linked to model purpose and use."
REPLICATING PORTFOLIO MODELS
Replicating Portfolio models replicate a deposit portfolio into simple financial instruments (e.g., bonds) such that its risk profile matches the risk profile of the underlying deposits. The advantage is that it converts a complex product into tangible financial instruments with a coupon and maturity. This simplified portfolio is well-suited to transfer risk from business units to treasury departments. A disadvantage of the model is that it does not fully capture non-linear deposit behaviour, for example the asymmetric pricing effects resulting from the floor. This makes the approach less suited for stress testing or ad-hoc behavioural risk analysis for senior management.
Read our extensive analysis of replicating portfolio models here.
HYBRID MODELS
Hybrid models, consisting of both a cash flow model and replicating portfolio model, combine the benefits of the other approaches, but at the cost of increased complexity. These models are often used by banks that want to use the model for a wide range of purposes: risk transfer to treasury departments, risk reporting, ad-hoc behavioural risk analysis, and stress testing. To prevent a larger mismatch between the models, most banks ensure that the risk profiles (duration or DV01) of both models align.
SAVINGS MODELLING SERIES
This short article is part of the Savings Modelling Series, a series of articles covering five hot topics in NMD for banking risk management. The other articles in this series are:
