Assessing the Stability of Your Deposits in a Rising Rate Environment

By Donna Thompson and Susan Maxey

It’s hurricane season once again and therefore time to ensure contingency plans are in place to deal with whatever Mother Nature throws our way. Are we properly stocked with water, battery-operated radios and food, and do we know our hurricane evacuation route? Likewise, it’s time to review interest rate risk (IRR) and contingency funding plan assumptions in anticipation of the eventual rise in interest rates.

Due to the prolonged low interest rate environment, limited investment opportunities and general uncertainty over the prospects for economic recovery, funds have steadily flowed into the banking system as many consumers and businesses have parked idle cash in bank deposits. This, coupled with increases to FDIC insurance limits and other initiatives to stabilize the financial system, has resulted in aggregate deposit growth in the banking system of about $2.1 trillion, or 28 percent, since 2007. Most of this deposit growth funded increases in securities and cash balances and provided the ability to pay down borrowings during this period of modest loan growth. Nonetheless, as interest rates begin to rise, history suggests that customers will find ways to more profitably deploy funds. As the remaining article discusses, we want to share some thoughts and observations that you should consider from a liquidity and contingency funding planning perspective as well as from a balance sheet management and interest rate risk viewpoint.

History shows that customers generally behave rationally during interest rate cycles. For instance, depositors are generally not willing to invest in longer-term instruments with stated maturities (i.e., CDs) during periods of low interest rates and instead prefer the immediate liquidity offered by deposits with indeterminate maturities. Conversely, in higher rate environments, customers appear willing to lock up funds in deposits with stated maturities, such as time deposits. This trend is evidenced in the chart below, as the volume of nonmaturity deposits held by financial institutions tends to move inversely with changes in the federal funds rate. The chart also shows that time deposits held by banks have been positively correlated, moving in the same direction as the federal funds rate. This relationship holds true for the current period as well, where the vast majority of recent deposit growth in this low interest rate environment has been concentrated in the nonmaturity deposit spectrum. Current data shows that nonmaturity deposits currently represent 60.4 percent of total deposits relative to an average of 53.6 percent over the past 10 years. Likewise, time deposits currently represent 39.5 percent of total deposits versus a 10-year average of 46.2 percent. As interest rates rise, time deposit rates are likely to again regain attractiveness relative to nonmaturity deposits, and some customers will eventually take the plunge and tie up a portion of funds in deposits with a stated maturity.


Don’t Become Complacent About Deposit Assumptions:

Because nonmaturity deposits are defined as “core deposits” from a regulatory perspective, the current influx of nonmaturity deposits may temporarily inflate banks’ liquidity metrics and core funding ratios. In addition, many liquidity forecasting tools model nonmaturity deposits as long-term stable funds. However, institutions should be aware that recent deposit inflows may exhibit more volatility than expected as interest rates rise and customers redeploy funds into more attractive investment opportunities. Without examining these assumptions in liquidity contingency funding plans, institutions may overstate the stability of these deposits in forward-looking liquidity metrics, making model results unreliable. To combat this potential issue, bank management should re-examine these assumptions periodically and exercise caution when assigning deposit stability assumptions based purely on historical information, as conditions or depositor behavior may change.

Re-evaluate Deposits Assumptions in Your Interest Rate Risk (IRR) Model:

From an IRR modeling perspective, nonmaturity deposits are typically assigned longer average lives and lower price sensitivities to rate changes than time deposits and other funding instruments. Often, nonmaturity deposits are less costly sources of funding as well. Given that the current volume of non-maturity deposits is high nationally compared with historic levels, earnings-at-risk and economic value of equity models that continue to use these artificially high levels in their modeling may distort the institution’s level of IRR exposure and overstate forecasted earnings and capital levels. While banks should model a static balance sheet for earnings-at-risk purposes consistent with regulatory guidance outlined in SR Letter 10-1, bank management should also run alternate scenarios to capture potential changes in depositor behavior.  Specifically, institutions that have witnessed significant deposit growth or have evidenced changes in the composition or mix of their deposit base are encouraged to run additional scenarios that capture the impact of deposit changes on the institutions’ interest rate risk profile.

Summary of Recommendations

  • Bank management should not automatically describe all nonmaturity core deposits as “stable” funds because this trend could reverse as interest rates rise or economic conditions change.
  • In compliance with SR 10-06, bank management should, among other things, ensure that contingency funding plans are reviewed, approved and updated with reasonable and supported deposit assumptions.
  • Bank management should ensure, for both liquidity and IRR modeling, that deposit runoff assumptions are appropriate, supported and documented in all scenarios.
  • Institutions should utilize their IRR models to run alternative scenarios beyond regulatory requirements in order to gain a greater understanding of IRR exposures.

In conclusion, regulators are concerned that the surge in deposits evidenced over the past few years might be short lived and the result of the low interest rate environment, economic uncertainty and other initiatives targeted at financial market stability. As interest rates rise and the prospects for economic recovery improve, banks should be prepared for potential deposit attrition and changes in deposit composition that can potentially lead to unreliable liquidity and IRR modeling.  Including these recommendations in your scenario planning toolkit, from both an interest rate risk and liquidity perspective, will better prepare your institution to navigate through the eventual rise in interest rates.

Donna Thompson is a supervisory examiner with the Federal Reserve Bank of Richmond. She can be reached at

Susan Maxey is a quantitative research analyst for the Federal Reserve Bank of Richmond. She can be reached at

The analyses and conclusions set forth in this publication are those of the authors and do not necessarily indicate concurrence by the Board of Governors, the Federal Reserve Banks, or the members of their staffs. Although we strive to make the information in this publication as accurate as possible, it is made available for educational and informational purposes only. Accordingly, for purposes of determining compliance with any legal requirement, the statements and views expressed in this publication do not constitute an interpretation of any law, rule or regulation by the Board or by the officials or employees of the Federal Reserve System.

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