A Story about When “Good” Isn’t Good Enough: Lessons from a Well-Intentioned Bank Manager

Many banks have managers who appear to be doing all the right things. They understand their clients, lead their teams effectively, follow the rules, and watch the numbers. But even with all this in place, things can go wrong — very wrong.

Let’s consider the case of one such "virtual" manager. 📌 A capable leader, trusted by his bank and their shareholders. He was known as a strong sales professional — successful in attracting new deposits and in placing loans with solid corporate clients. He inspired his team to follow his approach, focused on traditional banking products: loans and deposits.

He also understood the fundamentals of credit risk. The bank’s loans were granted with care, supported by internal financial analyses and credit ratings. Capital requirements? He followed regulatory guidance, maintaining capital at the required level — mainly to cover credit risks. He didn’t ignore liquidity either. He was aware of the requirement to hold a certain portion of the balance sheet in government bonds. Although these provided lower yields, he accepted their role as a highly liquid buffer.

From a profitability perspective, he was focused on the bank’s net interest income (NII) — carefully tracking the difference between interest income on assets and interest paid on liabilities. To prepare for future developments, his team ran NII scenarios for potential movements in interest rates, both upward and downward. He even looked at whether the bank’s capital base could absorb possible losses in some stressed scenarios.

It all seemed sound. Yet despite these efforts, the bank failed. 📉 What happened?

A period of financial market tension emerged. Interest rates rose sharply — not only short-term rates, but also long-term yields (5 to 10 years) became very volatile.

The bank’s loan portfolio consisted largely of long-term fixed-rate credits — mortgages and investment loans. The bonds' portfolio duration was also long-term. On the other side of the balance sheet, most deposits had undefined or short maturities. Under normal market conditions, these deposits were stable. But when market volatility increased, depositors either demanded significantly higher returns or withdrew their funds altogether in search of better alternatives. This presented the bank with a dilemma:

• Increase deposit rates to retain liquidity — at the cost of much higher funding expenses.
• Or lose liabilities altogether — risking a liquidity crisis.

This mismatch exposed the bank to significant interest rate risk (IRR). And while the manager had simulated scenarios for future NII, that was not enough. 📊 What was missing?

A comprehensive Asset and Liability Management (ALM) approach — one that integrates all dimensions of interest rate risk, not just income effects. In regulatory terms, this is addressed through the Interest Rate Risk in the Banking Book (IRRBB) framework. IRRBB doesn’t stop at NII projections. It also focuses on Economic Value of Equity (EVE) — the change in the economic value of a bank’s balance sheet overall IRR under various rate scenarios.

Had the bank assessed EVE under stress, it might have discovered that a shift or change in the yield curve — or a simple parallel rise in rates — would lead to a significant economic loss and erosion of capital. This mark-to-market effect was not captured by income-based models alone. 💡 What could have been done differently?

Several strategies were available, for example:

1️⃣ Adjusting the balance sheet structure to reduce exposure — for example, increasing the share of long-term liabilities or reducing fixed-rate assets. This is known as a 'natural hedge' and is particularly suitable for smaller or mid-sized banks that have limited access to derivative markets.

2️⃣ Using interest rate derivatives, such as swaps, to hedge part of the interest rate risk — exchanging fixed payments for floating ones. Of course, this may reduce short-term NII but can protect the bank from more severe losses in a stress scenario.

✅ The bank manager’s actions weren’t necessarily wrong. But they were incomplete. In today’s environment, being a professional banker means more than knowing products, managing teams, and meeting regulatory minimums. It means understanding the bank as a whole — managing risk not just by tradition, but through modern tools, analytics, and a balance sheet-wide perspective.

🧩 Do you recognize a manager like this? Someone who performs well — but may not be seeing the full picture?

At Bearning , we work with banks and their managers to help them develop this holistic view on financial management. Through practical training, simulations, and consulting, we support professionals in strengthening their skills in balance sheet management, ALM, and interest rate risk. Because even good bankers deserve the tools to become great ones.

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