Free Download PDF A Guide to Behavioural Modelling

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behavioural modelling for asset/liability management (ALM) or the treatment
of the uncommitted lines.
The activities of raising deposits from, and providing credit to, clients are
crucial for a commercial bank. 1 Both show a behavioural vein: the first
because clients can withdraw their deposits without notice, the second
because clients may prepay their loans before maturity. An understanding of
client behaviour is essential in commercial banks where NMDs are one of the
main sources of funding. The relevance becomes straightforward considering
that maturity transformation is a key function of banks. Commercial banks
have to transfer funds from clients in surplus demanding short-term deposits
to clients with long-term financing needs. A significant percentage of NMDs
are normally used by banks for funding medium long-term assets.
Furthermore, the maturity/duration transformation activity is an important
driver of the net interest margin as banks invest in long-term assets to hedge
their deposit franchise, which is due to banks’ market power in sight deposit
markets that allows them to keep deposit rates low even as the short rate
rises. By hedging their deposit franchise, banks earn a spread between the
long-term rates on loans and short-term rates on deposits.
NMD behavioural models are a crucial driver of the maturity
transformation activity and bank’s profitability since their goal is to estimate
the stable source of funding, the volume that can be used for medium longterm
lending and the volume that represents a stable/low cost fixed rate
liability to be hedge. On the other hand, the prepayment option, by reducing
the contractual weighted average life on a commercial loan portfolio, has an
impact on the actual maturity/duration transformation. The prepayment
behavioural models are important to assess the actual weighted average life
of medium long-term assets because their goal is to estimate how the
contractual profile of the loans will be reduced because of clients’
prepayment option. The shortening of the maturity profile has an impact on
bank’s liquidity position by increasing short-term liquidity inflows and
reducing medium long-term funding needs. Moreover, the shortening of the
assets’ duration affects the interest rate risk position and related hedging
strategy.
A stronger integration between credit risk models and the standard ALM
framework allows a better modelling of expected cashflows. The increase in
delinquency and default rates alters the amount and timing of contractual
cashflows and impacts bank’s liquidity and interest rate position. As by their
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