On January 6, the federal financial regulators, including the Federal Reserve, the FDIC, the OCC, the OTS, the National Credit Union Administration and the Federal Financial Institutions Examination Council State Liaison Committee, issued an advisory regarding the management of interest rate risk. The advisory reminds institutions of their responsibility to ensure the sound management of interest rate risk by the implementation of the following practices and procedures:
- Effective Corporate Governance - Each institution’s board of directors is responsible for overseeing the establishment, approval, implementation and annual review of policies regarding interest rate risk management exposure.
- Policies and Procedures - Institutions are expected to have comprehensive policies and procedures governing all aspects of their interest rate risk management process. “[Interest rate risk] tolerances articulated in an institution’s policies should be explicit and address the potential impact of changing interest rates on earnings and capital from a short-term and a long-term perspective.”
- Measuring and Monitoring of Interest Rate Risk - Institutions should have robust interest rate risk measurement processes and systems to assess exposures relative to established risk tolerances.
- Stress Testing - Stress testing, which includes both scenario and sensitivity analysis, is an essential component of interest rate risk management. “In general, scenario analysis uses the model to predict a possible future outcome given an event or series of events, while sensitivity analysis tests a model’s parameters without relating those changes to an underlying event or real world outcome.”
- Internal Controls and Validation - Institutions should have processes in place to ensure the integrity of their management of interest rate risk, which may involve an independent review and assessment of the institution’s measurement of interest rate risk, including “the reasonableness of assumptions, the process used in determining the assumptions, and the backtesting of assumptions and results.”