On October 8, 2013, the FDIC published Financial Institution Letter FIL-46-2013 to re-emphasize the importance of prudent interest rate risk management.  The FDIC’s tone was sharper than in the Advisory on Interest Rate Risk Management collectively published by the financial regulators over three years ago on January 6, 2010.

The FDIC identifies the nationwide trend of institutions reporting “a significantly liability-sensitive balance sheet position” and says in the letter that it “is increasingly concerned that certain institutions may not be sufficiently prepared or positioned for sustained increases in, or volatility of, interest rates.”  That is strong language!  The FDIC is clearly signaling its intent to focus intensely on the issue in upcoming examinations.

Some of the FDIC’s specific concerns about banks with a liability-sensitive balance sheets in a rising rate environment include:

  • Decline in net interest income;
  • Run-off of deposits;
  • Rate sensitive liabilities (e.g., deposits) re-pricing faster than earning assets.
  • Severe depreciation in a bank’s holdings of long-duration bonds;
  • Liquidity shortfalls resulting from dependence on a long duration bond portfolio for liquidity;
  • Decline in regulatory and equity capital due to investment portfolio depreciation; and
  • Negative publicity from drops in GAAP equity.

One of the asset-liability management practices the FDIC expects banks to use is the consideration of risk management strategies.  The FDIC reminds banks of the full array of interest rate risk management options, including:

  • rebalancing earning asset and liability durations,
  • proactively managing non-maturity deposits,
  • increasing capital, and
  • hedging.
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