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March 15, 2023

Optimizing Bank Performance: Streamlining Balance Sheet Stress Testing and Key Indicator Analysis with Workday Adaptive Planning

The last few days have been tumultuous for financial institutions as interest rates are on the rise and are still projected to increase by the end of 2023. With higher interest rates, the cost of borrowing increases, leading to a reduction in the demand for short-term and long-term loans, resulting in a decrease in revenue for banks. Additionally, rising interest rates encourage people to save money and earn higher interest payments, increasing the cost for banks. Apart from mortgages, rising interest rates negatively impact stock and bond markets, credit cards, and other financing options. 

This economic position highlights the need for "Balance Sheet Stress Testing" for banks. Forecasting and modelling the balance sheet to perform "What-If" scenario testing helps banks manage and mitigate Interest Rate Risk (IRR).  

What is IRR – Interest Rate Risk? 

Interest rate risk is the risk to a bank's earnings and capital that occurs when interest rates change, and it comprises four types of risk: repricing risk, basis risk, yield curve risk, and option risk.  

  • Repricing risk occurs when assets (loans and investments) mature or reprice at different times than liabilities (deposits and other borrowings). 
  • Basis risk arises when interest rate changes lead to a difference in how a bank’s assets are repriced versus its liabilities. 
  • Yield curve risk arises from nonparallel changes in the yield curve. The rate change on a two-year Treasury bond, for example, may differ from that on a 10-year Treasury bond. 
  • Option risk happens when the timing or amount of a bank’s cash flows changes because of a decision by a bank borrower (e.g., a loan customer) or lender (e.g., deposit customer). 

For community banks, repricing risk is the most significant concern. They must constantly monitor the mix of fixed-rate and floating-rate assets and liabilities on their balance sheets, as well as when those assets and liabilities mature or reprice and to what magnitude. 

Understanding a Bank’s balance sheet 

A bank's balance sheet is structured differently from other companies due to the nature of their business. Below is a breakdown of the typical balance sheet for a bank, which includes unique classes of line items: 

  • Property 
  • Trading assets 
  • Loans to customer
  • Deposits to the central bank
  • Loans from the central bank 
  • Deposits from customers 
  • Trading liabilities
  • Misc. debt
  • Common and preferred shares 

It's worth noting that the specific line items and categories on a bank's balance sheet may vary depending on the size and type of the institution. However, the overall structure typically follows this general framework. 

What is a bank balance sheet stress test? 

A bank balance sheet stress test involves conducting a series of simulations and analyses under hypothetical market conditions and economic variables to predict a bank's performance under adverse market conditions, such as a financial market crash or recession.  

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Examples of stress variables 

Stress tests are critical assessments that evaluate the financial resilience of banks during periods of financial instability. These tests involve running model simulations, which can be complex and challenging to execute since they rely on a multitude of variables. Conducting stress tests requires meticulous attention to detail and extensive analysis to ensure the models accurately reflect the potential impact of severe economic scenarios on a bank's financial health. Some of the key KPIs to track a bank’s financial health – Quick Ratio, Efficiency Ratio, Operating Expense as a Percentage of Assets, Total Loans Outstanding (Growth Rate), Total Deposits (Growth Rate), Non-Performing Loan Ratio and Loan Yield. 

How do we make balance sheet stress testing easy and agile? – Workday Adaptive Planning 

Workday Adaptive Planning is a leading FP&A planning and budgeting cloud-based solution that helps banks improve their balance sheet stress testing. The tool's framework enables scenario modeling, improving the agility and flexibility of the planning process by providing clarity on how the world could look against a range of potential paths. Powered by multidimensional, driver-based modeling, it empowers banks to monitor and make critical decisions using what-if analysis to support a healthy balance sheet. 

Workday Adaptive Planning features include scenario-based modeling, reporting and analytics, seamless data integration, forecasting and budgeting, scalability, integration with machine learning and artificial intelligence, and ease of use. It helps banks pivot easily and guides them to "Make good decisions during bad times." The tool has been recognized as a leading FP&A planning software in the market today, named as a leader by Gartner. If you are interested in elevating your organization's FP&A planning using Workday's Adaptive Planning, connect with Active Cyber to see how we can help. 

Want to learn more about our Financial and Margin Planning model using Workday Adaptive Planning? Take a look at our demo here: or contact us to get started.

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