March 8, 2018
Even with access to technology, a new study reveals that banks are failing to maximize the potential benefits of maturity transformation.
Maturity transformation is something that banks do daily as a matter of course. Using bank balance sheet management and technology to minimize risk and maximize returns is one of the ways that a bank can increase shareholder value. A recent study has revealed that banks may not be as effective as possible with their maturity transformation activities, even with the availability of advanced technology.
The process of maturity transformation has the potential to add shareholder value for banks.
The Practice of Using Maturity Transformation to Maximize Profits
Many investors are willing to make short-term investments, but a project might require a long-term financial commitment. Banks are able to lend long-term, such as with mortgages, but borrow short-term in the form of short-term CDs and demand deposits. When banks do this, they can transform a debt with short maturity into a credit with a longer maturity and hold onto the difference as profits.
The risk with maturity funding is that short-term lending costs will increase faster than a bank can recoup its money through lending. It may seem that advances in technology would allow banks to minimize those risks and maximize returns, but a new study reveals that this may not be the case.
The Failure to Produce a Maturity Transformation Edge
A recent academic paper co-authored by Erik Stafford from Harvard Business School and Juliane Begenau from Stanford addresses the question of whether or not banks are eroding shareholder value when they stray from pure maturity transformation activities. The assumption is that banks are better than capital markets at these practices because they have lower funding costs in the form of bank deposits, so they can get better returns on loan assets, and have cross-selling opportunities by having depositors and borrowers on the same balance sheet.
Stafford and Begenau tested this theory by creating a "passive bank" and simulating the maturity transformation activities using the same debt-to-equity ratio as actual banks. The paper concluded that the annualized returns on their "passive bank" were 2% higher, but it also had lower volatility than real-world banks. Even when they reduced the leverage to just 5x equity, they still outperformed real-world banks.
One of the conclusions of the paper was that what benefits the customers and society in general, such as small business lending, credit cards, and checking accounts, may not deliver the same degree of shareholder value. Banks remain capital and overhead-intensive operations, which eat into profits, even when using technology. The combination of cost-cutting and innovation such as AI may provide some of the headway that will allow real-world banks to maximize shareholder value in the future.
So far, banks are failing to minimize risk and maximize returns in their maturity transformation activities.
Partner with a Whole Loan Broker to Maximize Returns
U.S. banks are set to experience a profit windfall in 2018 with the recent tax overhaul, but there are other ways to increase value for bank shareholders. Now is the perfect time to evaluate loan portfolios to ensure that lenders are holding the right mix of assets for the current economic climate. A loan sale advisory service like Garnet Capital can help with this review as well as connect banks with buyers and sellers of loans in different asset classes.
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