Preparing for What You Can’t Predict in an Uncertain Market

Banks are operating against a backdrop of geopolitical risk, slowing growth and uncertain inflation. They face competing pressures, as interest rate expectations shift and competition from private lenders and new technologies intensifies. The fundamentals have not changed. Banks must still attract deposits and deploy capital effectively. What has changed is the level of oversight required to manage that responsibility in a more complex risk environment.

There are encouraging signs. Bank lending is showing signs of improvement in early 2026, driven by rising demand for commercial loans and stabilizing credit quality, with many banks reporting healthy and growing loan pipelines. But these improvements exist alongside persistent uncertainty. That tension is where governance matters most.

Start With the Business Model
Balance sheet risk begins with a bank’s business model. Institutions that lend long and fund short, largely remain liability sensitive, absent market interventions. Commercial banks with significant floating rate lending tend to be asset sensitive. These profiles are structural, not temporary.

While boards do not manage these exposures day-to-day, they must ensure management understands them, measures them and aligns them with strategy. The asset/liability management process should answer a core question: How does the balance sheet perform if rates move significantly in either direction? Recent history offers a clear reminder. Liability-sensitive institutions were constrained by meaningful unrealized losses when rates rose sharply. Many assumed that scenario was unlikely. Boards now need to confirm their institutions can withstand a similar outcome.

Asset-sensitive banks face a different risk. Rates may not decline sharply based on current market expectations, but they have before. Boards should ensure management prepares for that possibility.

Challenge the Assumptions
Standard stress tests only go as far as their assumptions. Boards should push management to go deeper. What happens if deposit betas lag or spike? How will bank customers respond to a competitor’s higher rates? If deposits leave, what does replacement funding actually cost? Will the bank rely on wholesale funding at significantly higher rates? How quickly can the balance sheet adjust? These second-order effects often create the greatest risk. They also present the greatest opportunity for strong governance.

Manage Risk With Purpose
Now more than ever, boards should view derivatives as key risk management tools for managing interest rate exposure and serving customer needs. To ensure the institution’s program remains effective in a rapidly changing market environment, directors should confirm that policies governing derivative use are clear, intuitive and aligned with the bank’s strategy. They should understand who can execute transactions, how the bank measures risk and how those strategies and transactions support the balance sheet. Instruments such as swaps, caps and floors should reduce exposure to adverse rate movements while preserving flexibility, with accounting friendly hedging solutions.

Customer hedging programs are also shifting. After a period of shorter-duration borrowing and smaller transactions, Chatham is seeing some bank clients showing renewed interest in longer tenors and larger exposures. That shift may reflect growing confidence in the economic outlook. Lending and hedging trends offer useful insights to frame larger risk management requirements.

Expect the Unexpected
The most significant risks are often the least predictable. Sharp rate movements, funding disruptions or external economic shocks can quickly reshape a bank’s risk profile. While boards can’t predict these events, they can prepare the bank for them. They should ensure management models a wide range of scenarios, including those well outside the base case. They should also confirm that risk management strategies are in place before those risks materialize.

Treat Governance as a Strategic Advantage
Effective governance does not rely on predicting the next market move. It depends on discipline. The most effective boards understand the business model, test assumptions rigorously and challenge management when needed. In a market where conditions shift quickly, that discipline creates an advantage. Banks that prepare for multiple outcomes can navigate uncertainty more effectively, support their customers and protect long-term value.