January 25, 2010
Authored by: Michael Shumaker
On January 7, 2010, the Federal Financial Institutions Examination Council (FFIEC), a collection of federal regulators of financial institutions, issued an advisory on interest rate risk management. This advisory, which was issued as part of an effort to supplement and clarify existing interest rate risk (IRR) guidance provided by individual federal regulators, indicates that federal regulators will have increased expectations during future examinations of a financial institution’s management, modeling, stress testing and documentation of IRR.
In light of the current economic environment in which financial institutions are experiencing downward pressure on capital and earnings, FFIEC has grown concerned with the potential IRR associated with institutions funding longer-term assets with shorter-term liabilities in order to generate earnings. As a result, as part of future federal examinations, IRR assumed by a financial institution will be evaluated relative to the institution’s capital and earnings levels, and management will be evaluated on its efforts to identify, measure, control and document the institution’s IRR.
In particular, FFIEC reiterates its previous position that the ultimate responsibility for the financial institution’s IRR rests with its board of directors; as a result, the board of directors or a specially designated asset/liability committee “should oversee the establishment, approval, implementation, and annual review of IRR management strategies, policies, procedures, and limits.” The board of directors is expected to receive and review regular reports that allow them to accurately assess the IRR sensitivity of the institution to an increasing rate environment and to the important assumptions that underlie management-proposed IRR and liquidity projections. Further, the board of directors is directed to approve comprehensive written policies and procedures in place to monitor and manage IRR continuously. Although the advisory indicates that these processes and systems “should be commensurate with the size and complexity of the institution,” FFIEC indicates that “well-managed institutions” possess IRR management policies that include specific targets under a variety of short and long term scenarios.