On January 6, 2010, the depository institution regulatory agencies, under the auspices of the Federal Financial Institutions Examination Council (“FFIEC”), issued an “Advisory on Interest Rate Risk Management” (“Advisory”). The Advisory reminds regulated institutions (including banks, savings associations and credit unions) of supervisory expectations regarding sound practices for managing Interest Rate Risk (“IRR”) and clarifies the agencies’ position on various IRR management matters.
The Advisory notes that some degree of IRR is inherent in banking. It stresses, however, that the regulators expect institutions to have effective policies and procedures to measure, monitor and control IRR. The Advisory notes that institutions should “manage their IRR exposures using processes and systems commensurate with their earnings and capital levels, complexity, business model, risk profit and scope of operations.” The Advisory makes clear that IRR management requires not only identification and measurement of IRR, but also appropriate action to control that risk. Institutions that determine that core earnings and capital are insufficient to control existing IRR must act to mitigate the risk and/or increase capital.
Highlights of the Advisory are:
The Advisory results from the regulatory concern that institutions may engage in strategies in the current environment without fully considering the IRR implications given an eventual rise in market rates. The Advisory notes that the current environment is one of historically low short-term interest rates and that institutions should have “robust processes” for measuring and, where necessary, reducing exposure to potential rate increases. The Advisory also recognizes (i) that institutions with increased loan losses and material declines in values of their securities portfolios are facing downward pressure on capital and earnings and (ii) that funding long-term assets with shorter-term liabilities can generate current earnings but at a risk to capital and earnings in future periods.
All regulated institutions are strongly advised to carefully read the eleven page Advisory.
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