Interest Sensitive Liabilities: What it Means, How it Works

What Are Interest Sensitive Liabilities?

Interest sensitive liabilities are types of short-term deposits with variable interest rates that a bank holds for customers. Interest sensitive liabilities make up a significant amount of the assets of most banks, encompassing money market certificates, savings accounts, and the Super NOW account.

Understanding Interest Sensitive Liabilities

Two major types of interest rates exist: fixed rate and variable rate. For example, a fixed interest rate is an interest rate on a liability, such as a loan or a mortgage, which remains the same for the entire term or a specified part of the term. Variable interest rates on a loan or security will fluctuate over time, based on an underlying benchmark interest rate or index, which periodically changes. Variable rates are also known as floating interest rates.

For consumers, advantages of fixed interest rates include steady payments over time as the interest rates on fixed-rate loans stay the same, making it easier to budget for the future. Disadvantages can include missing out on lower initial rates in variable loans. Variable interest rates on mortgages (often called adjustable-rate mortgages or ARMs) begin low and fixed for the first few years of the loan and adjust following this period.

As noted above, interest-sensitive liabilities are variable rate deposits (i.e., the deposits are sensitive to interest rate fluctuations). This means that their value changes with time. The goal of banks is to keep customer deposits for as long as they can, as it is how they loan money to other customers, earning interest on those loans, which translate to profits. Earning interest on deposits is attractive for customers as it allows a return on their money, as an investment, rather than just sitting in an account idly.

Common Interest Sensitive Liability Products

Examples of interest-sensitive liabilities include money market certificates, savings accounts, and the Super NOW account.

Money market certificates have high liquidity and very short maturities, ranging in duration from overnight to just under a year. Common money market instruments include eurodollar deposits, negotiable certificates of deposit (CDs), bankers acceptances, U.S. Treasury bills, commercial paper, municipal notes, federal funds, and repurchase agreements (repos).

Savings accounts are simpler products. Unlike checking accounts, savings accounts do bear some interest (a modest rate). Banks or financial institutions may limit the number of withdrawals from a savings account each month and can charge fees unless the account maintains a certain average monthly balance (e.g., $100).

Created in 1982, Super NOW accounts offer higher interest rates than Negotiable Order of Withdrawal (NOW) accounts but still offer a lower rate than a money market account.

Interest Sensitive Liabilities and Regulation Q

Regulation Q of the Monetary Act of 1980 began phasing out interest-rate ceilings by 1986. This phase-out, combined with the elimination of most early withdrawal penalties, increased the volatility of demand deposit holdings in customer accounts. Demand deposits are essential to a bank for making loans and earning interest (profit) on those loans. These changes resulted in banks having to adjust the management of their interest rate risk.