Pub. 8 2013-2014 Issue 4

www.nebankers.org 22 Extraordinary Service for Extraordinary Members. B ank regulators have again made clear their intention to highlight interest rate riskmanagement as a point of focus. The FDIC issued a Financial Institution Letter (FIL-46-2013) on Oct. 8 entitled “Managing Sensitivity to Market Risk in a Challenging In- terest Rate Environment.” Their concern, of course, is that many banks are not adequately prepared for, or equipped to manage, the risks to earnings and capital that would ac- company a sustained rising rate environment. This FIL fol- lows several other advisories and joint statements from the Federal Financial Institutions Examination Council (FFIEC) regarding interest rate risk and liquidity risk management. In the FIL, the FDIC points to concerns about recent trends in bank balance sheets. For example, a notable increase has occurred in long-term assets funded by liabilities that may be more rate sensitive than commonly thought. The FIL states: “For a number of FDIC-supervised institutions, the potential exists for material securities depreciation relative to capital in a rising interest rate environment.” The FIL also says: “Moreover, rate sensitive liabilities may re-price faster than earning assets as coupons on variable rate loans and investments remain below their floor.” Among other things, banks are reminded of the impor- tance of having a sufficiently detailed reporting system to keepmanagement and directors informed of interest rate risk exposures. Banks should have access to simulation models that produce stress tests on the overall balance sheet and particularly on high duration assets. Repricing assumptions for liabilities should be stressed as well. The FIL outlines four specific points: • Board and Management Oversight – Directors are charged with the responsibility of policy development and should have a clear understanding of the interest rate riskmanage- ment processes in place at their bank. Management is expected to provide the reporting tools and other resources necessary to carry out policy. • Policy Framework and Prudent Exposure Limits – Boards of directors should “for- malize” risk philosophy with sound policies and exposure limits that give management guidance on appropriate risk management strategy. • Effective Measurement and Monitoring of Interest Rate Risk – Management should utilize a variety of tools and techniques for assessing risk exposures. These should in- clude earnings simulations, stress tests, and EVE analysis among others. • Risk Mitigation Strategies – Use of hedging off-balance- sheet derivatives are only appropriate for institutions that have the knowledge, expertise, and resources to un- derstand and manage the potential risks and unintended consequences. Interest rate risk has been a priority for regulatory agencies for several years. Much has changed with respect to examiner expectations of bankmanagement teams and directors. Since the end of 2009, banks are required to build a more thorough ALCO process within a sound risk management framework. The release of this FIL is a helpful reminder that interest rate risk remains a top-of-mind issue as we move forward.  Managing Sensitivity to Market Risk FDIC Amplifies the Importance of Interest Rate Risk Management Jeff Caughron , The Baker Group Since 1979, The Baker Group has helped clients improve decision- making, manage interest rate risk, and maximize investment portfolio performance. The company’s proven approach of total resource integration utilizing software and products developed by Baker’s Software Solutions, combined with solid investment experience and advice, makes The Baker Group the investment firm of choice for many community financial institutions. For more information, contact Jeff Caughron at The Baker Group at (800) 937-2257 or jcaughron@GoBaker.com , or visit www. GoBaker.com.