Liquidity and Interest Rate Risk Questions to Consider Before Your Next Exam

With recent high-profile bank failures, rising interest rates, inflation, and economic uncertainty, examiners will be critically evaluating liquidity and interest rate risk management practices at your institution. Before your next exam, self-evaluating the effectiveness of your risk management practices is important. Here are some questions you can consider in that evaluation.

Governance Considerations

• Do policies provide adequate guidance for risks associated with asset/liability management?
• Have policies been approved by the Board in the prior 12 months?
• Do limits continue to be appropriate given the bank’s balance sheet and risk profile and in a dynamic rate environment?
• Are all policy limits compared to actual measurements to monitor for compliance?
• Are primary reports sufficiently defined, including consideration for purpose, content, frequency, and audience?
• Are key interest rate risk and liquidity risk assumptions defined, including consideration for basis, review, and stress testing?
• Are requirements for independent review established and defined?
• Are primary validation methods, such as internal review and backtesting, defined and tolerable variances established?
• Are positions, ratios, and forecasts subject to critical review?
• Do minutes clearly document the nature of Board/ALCO review and consideration of compliance with Policy limits?
• Are instances of noncompliance with Policy formally approved and/or presented with an action plan to address?
• Are rising and falling rate scenarios being measured, reported and critically discussed?

Liquidity and Funding Risk Management Considerations

• Have limits been established for on-balance sheet liquidity, noncore funding, and contingent liquidity and subjected to regular monitoring?
• Has the liquidity coverage ratio been considered and modeled?
• Have potentially volatile liabilities been defined (individually or in the aggregate), identified, and subjected to regular monitoring?
• Are potentially volatile liabilities subject to stress testing considerations?
• Is the usage of wholesale funding consistent with established strategy and supplemental to core funding?
• Are wholesale funding positions by source or type measured and compared to policy limits?
• Have unrealized losses on investments been adequately considered?
• Have funding sources been tested and availability confirmed?
• Are deposit, funding, and industry concentrations identified, monitored, and properly aggregated?
• Are stress testing scenarios appropriate given the bank’s liquidity risk profile?
• Do stress testing scenarios consider balance sheet liquidity and contingent liquidity?
• Does stress testing periodically consider true “worst case” scenarios?
• Does stress testing consider a “run” scenario?
• Is the impact of falling below the “well-capitalized” threshold and being subject to rate cap considered?
• Is forecasting of projected liquidity positions being prepared on a periodic basis?
• Is frequency of forecasting accelerated in a crisis or potential crisis event?
• Are relevant balance sheet liquidity categories included in the forecasting?
• Is the forecasting timeframe sufficient to enable management to proactively identify problems?

Interest Rate Risk Management Considerations

• Have limits been established for change in net interest income and change in economic value of equity in all rate shock scenarios and timeframes measured?
• Is the model adequate given the bank’s balance sheet or complexity of instruments?
• Is a sufficient range of scenarios being measured, such as dynamic vs. static, instant vs. gradual, or parallel vs. non-parallel?
• Is range of rate shocks sufficiently broad for rising- and falling-rate scenarios?
• Is the bank’s investment portfolio being measured for changes in unrealized gains/losses in dynamic rate scenarios?
• Do model projections align with the bank’s experience and actual direction of sensitivity?
• Are unique assumptions assigned for all relevant balance sheet categories?
• Have assumptions been differentiated for rising- and falling-rate scenarios?
• Is there a justifiable basis for critical assumptions, including historical analysis?
• Have qualitative adjustments been applied to historic data, and are adjustments supported?
• Are industry-based assumptions properly reviewed for appropriateness and compared to bank-specific data?
• Have critical assumptions been identified and subjected to sensitivity analysis?
  • Rate drivers
  • Asset prepayments
  • Deposit decay
  • Deposit pricing sensitivity
• Have model assumptions been reviewed by management and the ALCO in the prior 12 months?

Effective asset/liability management practices are always important and they are especially critical right now. Through our banking services practice, Weaver can help financial institutions assess risks, evaluate and meet independent review requirements associated with liquidity and funding practices, and develop processes and controls necessary for a strong risk management environment. Contact us for information.

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