The federal banking agencies have jointly issued an advisory to remind depository institutions of supervisory expectations for sound practices in managing interest rate risk. The January 6 Advisory on Interest Rate Risk Management reiterates the importance of effective corporate governance, policies and procedures, risk measuring and monitoring systems, stress testing, and internal controls related to the interest rate risk exposures of depository institutions. It also clarifies elements of existing guidance and describes interest rate risk-management techniques used by effective risk managers. The advisory states that the agencies expect each depository institution to manage its interest rate risk exposure using processes and systems commensurate with its complexity, business model, risk profile, and scope of operations. The advisory also reminds depository institutions that an effective interest rate risk-management system would not only involve the identification and measurement of interest rate risk, but also appropriate actions to control the risk. According to the agencies’ statement, if an institution determines that its core earnings and capital are insufficient to support its level of interest rate risk, it should take steps to mitigate its exposure, increase its capital, or both.

Nutter Notes: According to the advisory, senior management is responsible for ensuring that strategies, policies, and procedures for managing interest rate risk that are approved by the board of directors are appropriately executed within designated lines of authority and responsibility. The agencies recommend that such policies and procedures ensure that the interest rate risk implications of significant new strategies, products and businesses are integrated into the interest rate risk management process. Such policies and procedures also should document and provide for controls over permissible hedging strategies and hedging instruments. The agencies advise depository institutions to ensure that the assessment of interest rate risk is appropriately incorporated in firm-wide risk management efforts so that the interrelationships between interest rate risk and other risks are understood. An accompanying supervision and regulation letter issued by the Federal Reserve notes that although the advisory is targeted at depository institutions, the advice provided is also directly pertinent to bank holding companies. The supervision and regulation letter reminds bank holding companies that they should manage and control aggregate risk exposures, including interest rate risk, on a consolidated basis, while recognizing legal distinctions and possible obstacles to cash movements among subsidiaries.