This year has seen a number of interest rate increases by the Federal Reserve, and we are fully in dynamic rate territory. Because of this, bank examiners will continue to take a hard look at the effectiveness of your bank’s interest rate risk management. Weaver's financial institutions services team can help you understand and meet these compliance requirements.
To help prepare for your next exam, there are some tasks you should consider before the end of the calendar year to make sure your interest rate risk management is fully documented.
- Analyze model results – Look at the direction of sensitivity projected by your model for the past four quarters, then determine whether this directionality aligns with actual results. If your model indicates that you are liability-sensitive but your margin has increased, then you may need to evaluate your assumptions related to deposits. If the model indicates that you are asset-sensitive but your margin has held flat, then revisit your assumptions related to investments and loans. In addition, pay attention to model results for the down rate shocks. Many banks have not focused on these scenarios for the past few years, but rates do have room to decline…and could, given the right pressures on our economy. Be sure you understand the results in these scenarios and confirm that they are in line with both your policy limits and actual experience.
- Evaluate policy limits – Most community banks do not regularly change policy limits, but being almost three years into a rising-rate cycle may have changed your bank’s risk profile or risk appetite. Before submitting your policy to the Board for annual approval, take a critical look at limits for change in net interest income and change in economic value of equity to determine if they still reflect the bank’s risk tolerance. In particular, look at your limits for down rate shocks to determine if they continue to be appropriate.
- Support assumptions – Being three years into a dynamic rate environment provides most banks with sufficient data to quantitatively support key model assumptions, and examiners are expecting banks to move beyond default model assumptions. For most models, assumptions related to loan prepayments, deposit betas and deposit decay have the most impact on model results. Accordingly, each of these assumption sets should be supported with internal, quantitative analysis, and we recommend incorporating at least three years of data. For loan prepayments and deposit decay, determine what your bank’s experience has been and compare your internal results to assumptions currently employed in the model. For deposit betas, compare your overall deposit rate increases to Fed Funds rate increases in order to measure your actual pricing sensitivity, and compare these results to your current beta assumptions. For each of these assumption sets, consider providing your data to the model vendor and asking them to run an alternate scenario using your bank’s actual data so you can see the impact on model results.
- Review ALCO minutes – Review your minutes from 2018 to determine whether ALCO review and oversight are clearly documented. At a minimum, your minutes should clearly document ALCO review of key interest rate risk results, any significant trends, compliance with policy limits, key model assumptions and backtesting results. If your minutes do not clearly document ALCO review of these items, then your examiners may not be able to determine whether the ALCO is fulfilling its oversight responsibilities.
Interest rate risk management will continue to be an important topic for bank management, boards of directors and examiners in 2019. Staying on top of these key areas of risk management and documentation will contribute to a stronger governance framework.
If you have any questions about interest rate risk policies, modeling issues, or general risk management considerations in the current economic environment, Weaver would be happy to help. For more information, review our financial institutions page or contact us.
Disclaimer: This content is general in nature and is not intended to serve as accounting, legal or other professional services advice. Weaver assumes no responsibility for the reader’s reliance on this information. Before implementing any of the ideas contained in this publication, readers should consult with a professional advisor to determine whether the ideas apply to their unique circumstances.
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