Executive Summary
The current economic environment doesn’t offer any “good” investments. The COVID recession is different from anything we have experienced. This makes it difficult for banks to manage their investment portfolios without taking on undue interest rate risk.
There are three reasonable liquidity strategies for banks to pursue: (i) reduce investments, (ii) shift from value at risk from interest rate risk to credit risk, or (iii) stay short/choose not to decide. Reducing investments can be prudent if liquidity risk can be tempered through a combination of off balance sheet liquidity and enhanced liquidity within other earning assets. Stretching for yield by taking credit risk is also within the core competency of banks and can be considered. Finally, holding cash equivalents is the default option.
