Bank Financial Risk

MANAGING BANK FINANCIAL RISK: BANK OF THE PACIFIC COAST BANKING SCHOOL CASE

Asset & Liability Sensistivity as of 31 December 2003

As of 31 December 2003, the Bank held $450 million in interest rate-sensitive assets. As of the same date, the Bank had $293 million in interest rate-sensitive liabilities. At a gross level, the Bank is more asset sensitive than it is liability sensitive. The weighted average interest rate on the Bank's interest-sensitive assets is 5.27 percent compared with a weighted average interest rate of 1.645 percent on interest-sensitive liabilities. Thus, interest rate changes, in theory, would have a greater impact on the asset side of the Bank's balance sheet than on the liability side.

On the asset side of the balance sheet, however, investments and fixed-rate loans are less interest-rate elastic than are floating-rate loans. Thus, the $295 million in floating-rate loans are the most interest-rate sensitive of the Bank's assets. On the liability side of the balance sheet, certificates of deposit and long-term borrowing are less interest rate-sensitive than are the remaining interest rate sensitive liabilities, which total $158 million. The mean interest rate on floating rate loans (5.25 percent) is substantially higher than the weighted average interest rate (0.45 percent) on the $158 million in liabilities other than certificates of deposit and long-term borrowing. Thus, by any reasonable set of measurements, the Bank is more asset sensitive

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A second on-balance sheet strategy would be to cancel the proposed shareholder dividend and place the $125 million in the investment class assets now held by the Bank. Additionally, the withdrawal of $75,000 million in floating-rate loans and investing the funds in the investment class assets now held by the Bank would bring the total increase in lower-interest assets to $200 million. This strategy would lower the weighted average interest rate on interest-sensitive assets held by the Bank, and, in turn, would lower the interest rate margin. The interest rate sensitive gap would be minimized. The strategy, however, would (a) alienate the Bank's base of customers who depend on floating-rate loans and (b) alienate the Bank's shareholders. The costs to the Bank in terms of customer goodwill from the withdrawal of floating-rate loans would have negative effects on the Bank's performance for sometime into the future. The costs to the Bank of shareholder anger might mean the dismissal of the members of the Board and the Senior Executive Team at the Bank. A third on-balance sheet strategy would be to divert a combinations of funds from floating-rate loans, fixed-rate loans, and scheduled dividends into investment class assets now

Category: Economics - B