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Replicating investment portfolios

Many banks use a framework of replicating investment portfolios to measure and manage the interest rate risk of variable savings deposits. There are two commonly used methodologies, known as the marginal investment strategy and the portfolio investment strategy. While these have the same objective, the effects for margin and interest maturity may vary. We review these strategies on the basis of a quantitative and a qualitative analysis.

The freedom of variable savings

The interest expenses on variable savings are an important driver for a bank’s results. Unlike mortgage interest rates, for instance, there is no knowing when and to what degree the variable savings interest rate will be adjusted. The bank has the right to change this at any time. But how much freedom does the bank really have in this respect?

Approaches to modeling liquidity maturity

Savings and liquidity

Savers who place their cash in deposit accounts – and can withdraw the funds from their account at any time – are thus able to decide the liquidity profile of this important source of funding for banks. This is a very important consideration for bank risk managers. In an article about savings in the previous edition of Zanders Magazine, we showed that banks must include adequate modeling of the liquidity maturity as part of their integral liquidity management. But how should this modeling be approached?

Why is modeling essential?

Savings as a source of financing

For banks, using variable savings as a source of financing differs fundamentally from ‘professional’ sources of financing. What risks are involved and how do you determine the return?