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I am Howard Lothrop host of Echo Partners TV. I want to talk with you today about what
do you do once you realize your asset liability report shows your interest rate risk profile
going beyond where you'd like to see it. You know, how do you correct imbalances? Of course,
there are many ways to do this. Some of the traditional ways would be to use your investment
portfolio. If you wanted the increase asset sensitivity for example, you would sell off
some your longer securities, reinvesting in shorter term or floating. That would increase
asset sensitivity. That's a great strategy. It is a pricey strategy given the costs involved
in moving in and out of securities, and of course it's a strategy that's often recommended
by bond brokers who would do more business. At the other extreme are derivative strategies
and I'm going to give you a disclaimer right now. A big piece of my business is consulting
with banks on applying derivative strategies, particularly with respect to hedging fixed
rate loans. However, if you ask my clients I think you'll see that I am more often than
not, and by a wide majority, more often than not I recommend that they do not use financial
derivatives to correct an asset liability or interest rate risk imbalance. The reason
for this is that while you can eliminate or minimize basis risk and you can finetune your
asset liability change or your interest rate sensitivity change very exactly with an interest
rate derivative, you need to keep that powder dry. Save that for when you have a huge move
or a frightening imbalance in your interest rate risk. If it's keeping you up at night
then, yes, let's talk about interest rate derivatives. So, we've seen a simple cash
market solution and we've seen the other extreme a more complex derivative solution. So,what
do you do? Actually the most cost-effective and efficient way to correct asset liability
or interest rate risk imbalances at your bank is to do so organically and with respect to
your products mix and pricing. So if you need more asset sensitivity, get less aggressive
on your fixed rate loan pricing. Lose some of those deals. Get more aggressive on your
floating rate loan pricing. You want to add these assets and have good earning assets
at your bank. You know, adding or revising sensitivity through your organic product and
pricing decisions takes a while. It takes some time and it's akin to turning a battleship
or turning an aircraft carrier. It takes some time to do that and make it effective. The
reality of it is those sorts of organic and homegrown product and pricing driven changes
are the ones that are going to drive the biggest long-term results for you at the bank. See
you on the next episode