Seven areas of interest rate risk, where examiners are likely to focus
Rates have been unusually low for a sustained period. As a result, certain institutions may not be as focused upon the potential for rising rates or the impact it may have on their institution. Examiners are of course concerned that certain institutions may not be prepared for a sustained increase in, or volatility of, interest rates. Therefore, to address these concerns, the FDIC Division of Risk Management Supervision (RMS) has among other initiatives, reiterated their supervisory expectations. Based upon the FDIC’s Interest Rate Risk Case Study1, enumerated below is brief synopsis of areas that will more than likely receive additional scrutiny at your next IRR component examination.
1. Support for Model Assumptions
As most model assumptions will undoubtedly aect model results, model assumptions should be well documented, supported and approved. Where practicable and appropriate, institutions should use assumptions derived from its institution specific data and experience, such as pre-payment speeds on loans, non-maturity deposit decay rates and deposit betas.
2. Appropriate Risk Limits
IRR parameters related to risk limits of Net Interest Income (NII) and Economic Value of Equity (EVE) need to be established or revised to appropriately reflect the institution’s risk tolerances for NII and EVE. Analysis supporting the rationale of risk limits should be prepared. Additionally, policy guidelines (steps) should be established for IRR metrics that fall outside of policy risk limits.
3. Independent Review
Effective controls over the IRR management process include an independent review of the model (including model assumptions and methodologies). Many institutions are being criticized for not having an independent review performed, or for not having the review performed timely.
4. Monitoring and Reporting
A need for enhanced monitoring and reporting, including board and senior management oversight was recommended. Specifically areas of IRR exposures and policy limit exceptions should be reviewed and discussed. Such discussions should be well documented in the ALCO minutes.
5. Increased Exposure with Long Term Investments
As investments in long-term securities have increased in certain institutions, price risk may also have increased. As a result, in a rising rate environment, the securities value could be subject to decline. Institutions with longer-maturity security portfolios should prepare for the risk of declining fair values that may come as a result of higher interest rates.
6. Variable Rate Loans at Their Floors
Institutions with a significant amount of variable rate loans, which may be at their oor rate, could have a delay in an interest income benefit in a rising rate environment. This could continue until rising market rates surpasses the floor rate. The delayed benefit should be taken into consideration when reviewing model results.
7. Insufficient Analysis of Deposit Assumptions
Stale or unsupported deposit assumptions increase uncertainty and may pose unintended risk to earnings and capital. Non-maturity deposit assumptions are critical to generate reliable model results.
1Interest Rate Risk Case Study Report No. EVAL-16-004
Contact Larry Poppert, CPA
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