Josh Younger Explains How Banks Really Manage Rate Risk

Tracy Alloway (0:09)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:14)

And I'm Joe Weisenthal.

Tracy Alloway (0:15)

Joe, what do you know about the dark arts of asset liability management?

Joe Weisenthal (0:22)

Only things that have been told to us about it on the Odd Lots Podcast.

Tracy Alloway (0:26)

Wait, that's actually quite a lot.

Joe Weisenthal (0:27)

Yeah, no, that's true. It seems tough. Deposits can be flighty. Sometimes they can be stable.

Sometimes when rates go up, they get passed on to deposit. Sometimes they don't. Deposit betas change over time.

Some things that, yeah, that's about it.

Tracy Alloway (0:45)

No, that's pretty good. Podcast over, we're done.

Joe Weisenthal (0:47)

Podcast over.

Tracy Alloway (0:48)

No, you're absolutely right about your characterization of deposits. And I think one of the really interesting things about banking is it is kind of built on this tension, which is that in theory, I can put my money in a bank as a deposit, and then I am theoretically entitled to pull it out at any time.

And I, for one, can't really imagine a business where at any single point, I could see a majority of my customers suddenly vanish. But it is also true in practice that people who put their money in banks, they don't tend to move it around that much. And that is the thing, like the magic behavior that enables banks to actually lend money or buy assets like bonds and things like that.

Joe Weisenthal (1:38)

Yeah, and obviously part of the reason anyone is having this conversation still is, we remember this past March with SVB, but I recall at the time in some of our episodes around then thinking about how, I don't know if paradox is the word, funny is the word or weird it is, that on some models, bank deposits are extremely sticky and long duration. And I think there's that stat, maybe it's fake, but people are more likely to get divorced than leave a bank is one of those things that people say. And if you have a customer, that's great.

On the other hand, sometimes the deposits do leave and can leave in five seconds and it doesn't take very much. So it always seemed to me that rather, like I wonder, are deposits, do they exist on some continuum of sticky to long duration or are they more like Schrödinger's deposits, either they're there or they're not there, but that there's no sort of in-between stay?

Tracy Alloway (2:38)

Yeah, we did that great episode with Joe Abbate over at Barclays about bank deposits. And we've been joking on the podcast since that in order to improve the transmission of monetary policy, everyone needs to go out, do their market research, find a high paying bank account somewhere and actually move their money. And I am joking, but also kind of not. There is an interaction between banks and deposit rates and the effective transmission of monetary policy. I mean, banks are supposed to be the primary mechanism through which a lot of monetary policy is transmitted.

And so the question of how deposits are actually working. So whether or not they're sticky, whether or not that stickiness changes in an environment where rates are going up or down, and also how those deposits sort of feed into monetary policy, that is a really big topic. And I think we should do more on it.

Joe Weisenthal (3:35)

Totally. You know, the thing that really strikes me in this is, a bank run is the perfect example of non-linearity, right? And so something is one state, and then something is suddenly a very different state. And we went from, and I think we've learned in recent times how tricky that is to manage. And I think understanding the actual management of that non-linearity in practice is something we can dive into further.

Tracy Alloway (4:01)

Right, and I did call it the dark art of asset liability management at the opening. And to some extent, it is kind of opaque. Like no one gets a lot of transparency into how an individual bank is actually managing things like deposit and interest rate risk. So, I'm glad we can do this episode. And more than that, we are really doing it with the perfect guest.

We have someone who's been on Odd Lots many times now.

Joe Weisenthal (4:25)

He's now climbing the ranks.

Tracy Alloway (4:27)

Oh really?

Joe Weisenthal (4:27)

Don't you think? I mean, of the most-

Tracy Alloway (4:29)

He must be.

Joe Weisenthal (4:30)

He must be, I mean, he's up there.

Tracy Alloway (4:31)

Yeah, all right. So, we're gonna be speaking to one of our perennial favorite guests, Josh Younger, formerly of JPMorgan, now a senior advisor over at the Federal Reserve Bank of New York.