BY ALEC HOLLIS
The use of non-maturity deposits is becoming more widespread, making proper modeling of them increasingly important. Given the many types of these accounts, however, irregularities in deposit behavior can make modeling difficult. Read on for some key insight that may make the effort a bit less complicated.
Quite possibly, the most controversial aspect of asset liability management (ALM) modeling is valuing non-maturity deposits (NMDs). As the name implies, an NMD is a deposit that has no maturity date; funds can be withdrawn by the accountholder at any time. Major types of deposit accounts are savings, checking (transactional), money market and others, such as club accounts. Each has its own set of requirements and regulations, and differing regulations and limitations lead to unique behavior by account.
Given the widespread, growing usage of NMDs, proper modeling of these accounts has become increasingly more important. Further, the modeling methods for NMDs have strong implications on the modeled interest rate risk (IRR) of a balance sheet.
NMDs generally comprise a rather significant majority of an institution’s liabilities and can be rather difficult to model given the irregularities in deposit behavior. NMD cash flows have no contractual principal component, and deposits can come in or be withdrawn without notice. To further complicate matters, the interest component is also subject to change at any time, although the interest rate is determined by each credit union’s management team. NMD risk is more behaviorally driven than any other balance sheet instrument and thus measuring its IRR is much more abstract than measuring, for example, the IRR of a treasury bond or even a mortgage-backed security. Ultimately, the risk of an NMD account is determined by the combined effect of institution and depositor behavior, so the goal is to model these behaviors in different interest rate scenarios. Institution-driven behavior relates to how management sets dividend rates. Depositor-driven behavior relates to factors that cause funds to be withdrawn or deposited.