Pub. 9 2014-2015 Issue 6

www.nebankers.org 20 Extraordinary Service for Extraordinary Members. O NCE AGAIN, REGULATORS ARE EMPHASIZING THE importance of sound interest rate risk (IRR) man- agement systems and processes. The winter 2014 issue of the FDIC’s Supervisory Insights publication is dedicated almost entirely to the subject. It contains articles discussing specific IRR topics including key assumptions analysis for measurement systems, corporate governance processes, detail on examiner expectations, and a general framework of independent review of overall Asset-Liability Committee (ALCO) processes. This last subject, independent review of processes, has been a particular source of confusion for many bankers with respect to the exact scope and mean- ing of the guidance. The FDIC reminds us: “Banks are expected to monitor the effectiveness of their key internal controls either as part of the internal audit pro- cess or by means of an appropriate independent review, and the framework for managing IRR is no exception.” To this end, management should routinely review and assess the effectiveness of the bank’s policies, processes, and procedures for measuring and managing IRR. The findings of this assessment should be reported annually to the board of directors. Notably, it is made clear that the review may take the form of an internal audit. The FDIC points out that there is no single template for a proper independent review. While a third partymay be engaged to do the review, the FDIC specifically notes: “There is no requirement or expectation for a bank to hire a consultant, and most community banks should be able to identify an existing qualified employee or board member to periodically conduct this review.” The article outlines five elements that give struc- ture to the goals of an independent ALCO review. In particular, the review should assess the following elements: 1. Adequacy of the internal con- trol system—are reasonable policies established and being followed? 2. Appropriateness of the risk measurement system—does the model capture necessary components of risk, given the complexity and characteristics of the bank? 3. Accuracy and completeness of the data inputs into the risk measurement system—is accurate data going into the model, and are key behavioral assumptions reasonable? 4. Reasonableness and validity of scenarios used in the measurement system—is risk to earnings and risk to capital adequately measured through simulation analysis and stress testing? 5. Validity of the risk measurement calculations—has the vendor secured validation of the math and meth- odology of the model itself, and have our bank’s prior reports been back-tested? Most of the five elements above ad- dress corporate governance concepts that are, of course, important. From the standpoint of proper measurement, however, the essential part of the in- dependent review involves assessing the data and key assump- tions that go into the IRR measurement system (element No. 3 on the list). Obviously, the raw inputs must be accurate and broken Conducting an Independent Review of ALCO Processes: Clarity From FDIC Jeffrey E. Caughron , COO/Managing Director, The Baker Group LP