For many banks, deals based on interest rate differences are one of the most important sources of income. In particular, banks with a large number of core deposits, i.e. positions with no fixed maturity (such as savings, sight deposits, current accounts and overdrafts), are exposed to considerable interest rate and liquidity risks. Due to customers’ withdrawal and cancellation rights there can be fluctuations in the volumes of these core deposits that greatly increase the difficulties involved in risk management.
The Margin Optimiser is a unique new tool for actively quantifying and controlling the risk potential of core deposits. By analysing thousands of scenarios of market yield curves as well as customer rates and volumes, the Margin Optimiser calculates efficient policies for investment and funding while allowing for the relevant risks. This makes it possible for banks to achieve sustainable stabilization and increases in interest income.
Approaches used up until now have typically transformed variable positions according to a constant factor into a replicating portfolio consisting of products with fixed interest. However, a portfolio constructed in this way will only react belatedly to changes in the interest rate environment; this means that the current situation in money and capital markets is not adequately taken into account.
Prof. Dr. Karl Frauendorfer, Director of the Institute for Operations Research at the University of St. Gallen explains: “A static view leads to a risk model that is both superfluous and difficult to control. The Margin Optimiser, on the other hand, dynamically adapts the portfolio to relevant market characteristics, the specific situation of the bank and the expectations regarding the evolution of risk factors. Implementing the Margin Optimiser results in either significantly lower funding costs or higher yields within the same levels of volatility of the average funding or investment rate.”
Dr. Robert E. Fiedler, Head of ALM & Risk at FERNBACH-Software S.A., further reveals the significance of the Margin Optimiser as follows: “The management of core deposits is not only important from an economic point of view but also influences the interest rate risk in the banking book, the regulation of which plays a central role in the second pillar of Basel II (quasi capital adequacy through the 20% outlier regulation). Furthermore, under some circumstances, core deposits are to be taken into account in macro hedging within the context of IFRS Accounting”.
The methods and principles behind the Margin Optimiser are the result of several years of research at the Institute for Operations Research. The resulting tool combines this research with the deep business and technical expertise gained by FERNBACH in providing solutions, in the fields of Asset/Liability & Liquidity Risk Management as well as for Basel II and IFRS, to major European banking institutions.
Günther Fernbach, CEO of FERNBACH-Software S.A., emphasizes the benefit of this synergy, saying: “The cooperation with the Institute for Operations Research at the University of St. Gallen, a body recognized worldwide in the field of optimisation techniques as well as for its expertise in applying the latest scientific models to real economic problems, underlines our commitment to continuing to provide the financial services industry in the future with standard software that distinguishes itself not only by its functionality and state-of-the-art technology but above all by its leadership regarding addressing business issues and new methodologies.”
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