The Federal Deposit Insurance Corporation issued an "Advisory on Interest Rate Risk Management to "remind institutions of ... sound practices for managing interest rate risk (IRR)." The publication says, "In the current environment of historically low short-term interest rates, it is important for institutions to have robust processes for measuring and, where necessary, mitigating their exposure to potential increases in interest rates."
The Advisory explains, "Current financial market and economic conditions present significant risk management challenges to institutions of all sizes. For a number of institutions, increased loan losses and sharp declines in the values of some securities portfolios are placing downward pressure on capital and earnings. In this challenging environment, funding longer-term assets with shorter-term liabilities can generate earnings, but also poses risks to an institution's capital and earnings."
It continues, "The regulators recognize that some degree of IRR is inherent in the business of banking. At the same time, however, institutions are expected to have sound risk management practices in place to measure, monitor, and control IRR exposures. Accordingly, each of the financial regulators have established guidance on the topic of IRR management.... The regulators expect all institutions to manage their IRR exposures using processes and systems commensurate with their earnings and capital levels, complexity, business model, risk profile, and scope of operations."
The FDIC says, "When conducting scenario analyses, institutions should assess a range of alternative future interest rate scenarios in evaluating IRR exposure. This range should be sufficiently meaningful to fully identify basis risk, yield curve risk and the risks of embedded options. In many cases, static interest rate shocks consisting of parallel shifts in the yield curve of plus and minus 200 basis points may not be sufficient to adequately assess an institution's IRR exposure. As a result, institutions should regularly assess IRR exposures beyond typical industry conventions, including changes in rates of greater magnitude (e.g., up and down 300 and 400 basis points) across different tenors to reflect changing slopes and twists of the yield curve."
Finally, the Advisory says, "Assumptions about non-maturity deposits are critical, particularly in market environments in which customer behaviors may not reflect long-term economic fundamentals, or in which institutions are subject to heightened competition for such deposits. Generally, rate-sensitive and higher-cost deposits, such as brokered and Internet deposits, would reflect higher decay rates than other types of deposits. Also, institutions experiencing or projecting capital levels that trigger brokered and high interest rate deposit restrictions should adjust deposit assumptions accordingly."
