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The ECB lowered key interest rates several times between 2009 and 2019, and in June 2014 it even introduced penalty interest rates - a trend that has since reversed significantly. In our white paper "Deposit modelling in a low interest rate environment", we look back at this turbulent period to draw lessons for banks for the future.

It is clear that the low-interest phase of the past years presented many banks with the challenge of stabilising their earnings situation. In particular, banks with high deposit volumes that were oriented towards traditional deposit models suffered from a creeping margin compression.

Traditional insole models were successful for a long time

For a long time, these traditional deposit models had successfully served to determine in which maturities the deposits should be invested in order to achieve as constant and positive a margin as possible - and to avoid potential risks. However, they were based on the assumption that interest rate changes could always be passed on to clients. However, this was no longer necessarily the case in the low-interest phase. Rather, many banks were reluctant to do so out of fear of the customers' reactions, but also because of legal hurdles. As a result, many banks were threatened with a negative margin from the deposit business.

In order to counteract this, some banks relied on active management activities, such as enforcing deposit fees and cross-selling. However, this could not fully compensate for the negative effects.

Possible measure: Swaption-based steering approach

Banks have therefore been and are being forced to rethink and develop new approaches and methods for managing and investing deposits.

One possible approach to hedging is the strategy of a rolling portfolio of swaptions presented in the white paper. This approach, developed by Sparkasse KölnBonn, can reduce margin compression effects in deposit models. In this way, profit and loss accounts (P&L) can be stabilised in phases of continuously low or successively declining interest rates.

Such a swaption approach is particularly suitable if the bank expects falling or constant interest rates with not too high volatility. This means that the conscious assessment of market developments, in particular an interest rate opinion, plays an important role in the application of the model.

These measures, presented in detail and with the help of examples in the white paper, could be used in the future to stabilise the earnings situation before or when a new low-interest phase occurs. We recommend banks to take these findings into account and to use the "lessons learned" of the past for themselves.

Download whitepaper here