An Application of Management Science to Bank Borrowing Strategies

The twelve Federal Land Bank of the Farm Credit System borrow large amounts in the capital markets to provide funds for their farm lending activities. Each year these privately owned banks sell $5 to $6 billion of bonds in a series of quarterly sales to refund maturing bonds and provide new funds for loan growth. The decision problem each quarter is to select maturities for the current sale. This is a complicated decision that must take into account current interest rates for alternative maturities, uncertain costs of future borrowing, perceived marketability of various maturities, and policy quidelines adopted by the Banks.

To help in the maturity selection, we developed a linear programming model that has been used as part of the quarterly decision-making process since mid-1974. We also developed a procedure for using the model so that it helps evaluate borrowing strategies in an uncertain interest rate environment. Keys to the success of the procedure are management's involvement in helping to specify possible future interest rate scenarios and in identifying specific borrowing strategies that are both practical and potentially desirable, given the range of possible rate environments. The model is used at an early stage to identify borrowing strategies appropriate to each interest rate scenario and later to evaluate the externally specified strategies across rate environments. From this analysis we are able to recommend bond maturities that provide a good balance between the objectives of keeping current costs low and limiting risks associated with uncertain future interest rates.