TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
Enclosed is an interagency policy statement approved by the Board of
Governors of the Federal Reserve System, the Office of the Comptroller of the
Currency and the Federal Deposit Insurance Corporation that provides guidance to
examiners and bankers on sound practices for managing interest rate risk. These
practices will form the basis of the agencies' ongoing evaluation of the adequacy of
interest rate risk management at their supervised institutions. The policy will become
effective upon being published in the Federal Register which is expected in the next
few days.
Also, the preamble to this statement formally notifies the industry that the
banking agencies have elected not to pursue a standardized supervisory measure of
interest rate risk that was issued for public comment in August 1995. In supervising
interest rate risk, the agencies intend to emphasize reliance on internal measures of
risk, promotion of sound risk management practices, and continued use of surveillance
screens to identify those institutions that appear to be taking excessive risk.
This policy statement outlines the fundamental elements of sound
management that have been identified in prior Federal Reserve guidance1 and
discusses the importance of these elements in the context of managing interest rate
risk. Specifically, the guidance emphasizes the need for active board and senior
management oversight and a comprehensive risk management process that effectively
identifies, measures and controls interest rate risk. The assessment of interest rate
risk management made by examiners in accordance with the joint policy statement will
be incorporated into a bank's overall risk management rating.
The guidance targets interest rate risk management at commercial
banks and Edge Act corporations2 and supersedes SR 90-41 "Interest Rate Risk"
which identified minimum interagency supervisory guidelines. The basic principles
presented in this policy statement also apply to bank holding companies, which should
manage and control aggregate risk exposures on a consolidated basis, while
recognizing legal distinctions and possible obstacles to cash movements among
subsidiaries.
Please forward this SR letter to all institutions supervised by the Federal
Reserve in your district.
Director
Cross References:
DEPARTMENT OF THE TREASURY
FEDERAL RESERVE SYSTEM
Joint Agency Policy Statement: Interest Rate Risk
AGENCIES: Office of the Comptroller of the Currency (OCC), Treasury; Board of
Governors of the Federal Reserve System (Board); and Federal Deposit Insurance Corporation
(FDIC).
ACTION: Joint policy statement.
SUMMARY:
The OCC, the Board, and the FDIC (collectively referred to as the agencies)
are issuing this joint agency policy statement (policy statement) to bankers to provide
guidance on sound practices for managing interest rate risk. The policy statement identifies
the key elements of sound interest rate risk management and describes prudent principles and
practices for each of these elements. It emphasizes the importance of adequate oversight by a
bank's board of directors and senior management and of a comprehensive risk management
process. The policy statement also describes the critical factors affecting the agencies'
evaluation of a bank's interest rate risk when making a determination of capital adequacy.
The principles for sound interest rate risk management outlined in this policy statement apply
to all commercial banks and FDIC-supervised savings banks (banks).
FOR FURTHER INFORMATION CONTACT:
OCC: Christina Benson, Capital Markets Specialist, or Margot Schwadron, Financial Analyst,
(202/874-5070), Office of the Chief National Bank Examiner; Michael Carhill, Deputy
Director, Risk Analysis Division (202/874-5700); and Ronald Shimabukuro, Senior Attorney,
Legislative and Regulatory Activities Division (202/874-5090), Office of the Comptroller of
the Currency, 250 E Street, S.W., Washington, D.C. 20219.
Board of Governors: James Embersit, Manager (202/452-5249), or William Treacy,
Supervisory Financial Analyst (202/452-3859), Division of Banking Supervision and
Regulation; Gregory Baer, Managing Senior Counsel (202/452-3236), Legal Division, Board
of Governors of the Federal Reserve System. For the hearing impaired only,
Telecommunication Device for the Deaf (TDD), Dorothea Thompson (202/452-3544), Board
of Governors of the Federal Reserve System, 20th and C Streets, N.W., Washington, D.C.
20551.
FDIC: William A. Stark, Assistant Director (202/898-6972) or Miguel Browne, Deputy
Assistant Director (202/898-6789), Division of Supervision; Jamey Basham, Counsel,
(202/898-7265), Legal Division, Federal Deposit Insurance Corporation, 550 17th Street, N.W., Washington, D.C. 20429.
SUPPLEMENTARY INFORMATION:
II. FDICIA Requirements and Agencies' Response
The final rule did not adopt a measurement framework for assessing the level of a
bank's interest rate risk exposure, nor did it specify a formula for determining the amount of
capital that would be required. The intent of the agencies at that time was to implement an
explicit minimum capital charge for interest rate risk at a future date, after the agencies and
the industry had gained more experience with a proposed supervisory measure that the
agencies issued for comment in August 1995. See 60 FR 39495 (August 2, 1995).
The agencies have undertaken considerable efforts to develop a supervisory measure
for interest rate risk that provides sufficient accuracy, transparency, and predictability for
establishing an explicit charge for interest rate risk. These efforts, and the comments the
agencies received on them, are summarized in sections III and IV that follow. After careful
consideration of those comments and additional analyses and research by agencies' staff, the
agencies have decided that concerns about the burdens, costs, and potential incentives of
implementing a standardized measure and explicit capital treatment currently outweigh the
potential benefits that such measures would provide. The agencies are cognizant that
techniques for measuring interest rate risk are continuing to evolve, and they do not want to
impede that progress by mandating or implementing prescribed risk measurement techniques.
Rather, the agencies wish to work with the industry to encourage efforts to improve risk
measurement techniques. These efforts, the agencies believe, may lead to greater convergence
within the industry on the methodologies used for measuring this risk and may, at a future
date, facilitate more quantitative and explicit capital treatments for interest rate risk.
Hence, the agencies have concluded that the best course of action at this time, is to
continue to assess capital adequacy for interest rate risk under a risk assessment approach and
to provide the industry with further guidance on prudent interest rate risk management
practices. Section V of this preamble describes the agencies' risk assessment approach for
capital. The policy statement, which follows section V, provides the agencies' guidance and
expectations on sound interest rate risk management.
Since the enactment of FDICIA, the agencies have issued two notices of proposed
rulemakings on interest rate risk, as well as one advance notice of proposed rulemaking
(ANPR).
The ANPR was issued in 1992 and sought comment on a proposed supervisory
measurement system and an explicit capital requirement based on the results of that
measurement system. See 57 FR 35507 (August 10, 1992). The measurement system
proposed in the 1992 ANPR would have applied to all banks and used a duration-weighted
maturity ladder to estimate the change in a bank's economic value for an assumed 100 basis
point parallel shift in market interest rates. Under the 1992 ANPR, a bank whose measured
exposure exceeded a threshold level, equivalent to 1 percent of total assets, would have been
required to allocate capital sufficient to compensate for the estimated change in economic
value above the threshold level.
The agencies received approximately 180 comment letters on the 1992 ANPR. The
majority of commenters raised concerns about the accuracy of the proposed measure and its
use as a basis for an explicit capital charge. Therefore, in September 1993, the agencies
published a notice of proposed rulemaking which incorporated numerous changes to the 1992
ANPR in an effort to address those concerns and improve the proposed model's accuracy.
See 58 FR 48206 (September 14, 1993). These changes included:
The September 1993 proposal also sought comment on allowing banks to use their
own internal models as the basis for establishing a capital charge and on two different
methods for assessing capital. One method, referred to as the minimum capital standard,
would establish an explicit capital charge for interest rate risk based on either the supervisory
model or a bank's internal model results. The other method, referred to as the risk assessment
approach, would evaluate the need for capital on a case-by-case basis, considering both
quantitative and qualitative factors.
In August 1995, along with the final rule amending risk-based capital standards to
adopt the risk assessment approach, the agencies issued for comment a joint policy statement
that would establish a supervisory framework for measuring banks' interest rate risk
exposures. See 60 FR 39495 (August 2, 1995). The results of that framework would be one
factor that examiners would consider in evaluating a bank's capital adequacy for interest rate
risk. In addition, the agencies noted that the framework was intended to provide the
foundation for the development of an explicit capital charge once the agencies and industry
gained more experience with the measurement framework.
Although these modifications were designed to enhance the agencies' earlier proposals,
the majority of commenters on the August 1995 proposal reiterated many previous concerns
about accuracy, burden, and incentives, and urged the agencies to reconsider their approach
and efforts to devise a uniform and standardized model.
IV. Factors Leading to the Agencies' Decision to Not Pursue a Supervisory Model
Throughout the evolution of the agencies' efforts to incorporate an explicit capital
charge for interest rate risk into their risk-based capital standards, industry comments have
expressed four fundamental concerns:
The agencies continue to believe economic value sensitivity is a valid and important
concept, especially when assessing an institution's capital adequacy and, as noted, have
amended their capital standards to reflect this view. Nonetheless, the agencies recognize that
changes in a bank's reported earnings are also important and that a bank needs to consider
both earnings and economic perspectives when assessing the full scope of its exposure. This
policy statement adopted by the agencies sets forth principles for monitoring and controlling
interest rate risk from both of these perspectives.
The industry's concerns about the validity and accuracy of a standardized model
present a more difficult and serious issue. Some of the changes in the August 1995 proposal
attempted to address these concerns. For example, supplemental schedules for residential
mortgage loans and pass-through securities were a response to earlier industry concerns
regarding the use of prepayment assumptions that were based on an average of outstanding
mortgage securities. By collecting additional data on the embedded options in an individual
bank's mortgage portfolio, the accuracy of the proposed model was potentially enhanced.
However, the changes were not without cost. In particular, the supplemental schedules and
associated risk weights added to the reporting burden and overall complexity of the proposal.
By giving the appearance of providing a more precise measure of risk, they also increased the
likelihood that the standardized measure would replace or stifle development of yet more
accurate internal measures of risk exposure. This added reporting burden and complexity
illustrates the difficulties the agencies have faced in trying to strike an appropriate balance
between accuracy and burden.
Not only did the mortgage schedules add burden, they did not fundamentally solve the
difficulties of structuring a standardized model which could take into account the
heterogenous nature of commercial banks' balance sheet structures and activities. In recent
years, banks have been offering and holding a growing variety of products. Many of these
products, such as certain collateralized mortgage obligations and structured notes, can have
complex cash flow characteristics that vary significantly with each transaction. The August
1995 proposal attempted to address this problem by requiring banks to self-report the
sensitivity of these and certain other instruments. The diversity and complexity in banks'
holdings, however, are not limited to a bank's investment and off-balance sheet instruments.
Increasingly, banks have a variety of pricing indices and embedded options incorporated into
their commercial and retail bank products, making it increasingly difficult to model these
products with any simple and uniform measure.
The diversity and complexity of commercial banks' balance sheets is one reason why
the banking agencies have decided not to pursue adopting the net portfolio value model
developed and used by the Office of Thrift Supervision (OTS) or any uniform supervisory
model. Although the banking agencies have benefited a great deal from the expertise and
experience of the OTS in this area, the OTS model was designed to ascertain the interest rate
risk exposure of insured depository institutions with concentrations of residential mortgage
assets, especially adjustable rate mortgages. These instruments require data-intensive,
complex models to obtain accurate valuations and interest rate sensitivities. Since most
commercial banks do not hold high concentrations of these instruments, the agencies were
concerned about the substantial reporting requirements and measurement complexity that
would be associated with an OTS type of model if applied to commercial banks.
Many industry commenters believe that the agencies' treatment in the August 1995
proposal of non-maturity deposits understated their effective maturity and urged the agencies
to allow banks greater flexibility in the reporting and treatment of them. Assumptions about
the effective maturity of these deposits are critical factors in assessing most commercial
banks' interest rate risk exposure, since these deposits often represent 40 percent or more of a
bank's liability base. Thus, while the agencies have elected not to adopt supervisory
assumptions for calculating the effective maturities of non-maturity deposits, the policy
statement cautions banks to make reasonable assumptions about customer behavior in this
area, and periodically re-evaluate whether the assumptions are reasonable in light of
experience.
The supervisory treatment of non-maturity deposits in measuring interest rate risk also
illustrates the industry's concern regarding the potential incentives a supervisory model could
present to a bank. In particular, some industry commenters have stated that if the agencies
adopted assumptions that understated the effective maturities of a bank's non-maturity
deposits, it could induce a bank to inappropriately shorten its asset maturities, leave the bank
exposed to falling interest rates, and unnecessarily reduce its net interest margins. The
agencies, however, are also concerned that an assumption that overstated the maturity of these
deposits could mistakenly lead banks to extend their asset maturities, leaving them exposed to
rising interest rates and significant loss in economic value.
Many commenters voiced broader concerns about the potential incentives that a
standardized supervisory model may have on how banks manage and measure their risk. A
frequent concern has been that a supervisory model would become the industry standard
against which internal models would be benchmarked and tested, thus diverting resources
away from improving internal models and assumptions.
The agencies neither wish to create inappropriate incentives, nor divert industry
resources from the development of better interest rate risk measurements. The policy
statement consequently emphasizes each institution's responsibility to develop and refine
interest rate risk management practices that are appropriate and effective for its specific
circumstances.
The risk assessment approach that the agencies use to evaluate a bank's capital
adequacy for interest rate risk relies on a combination of quantitative and qualitative factors.
The agencies will use various quantitative screens and filters as tools to identify banks that
may have high exposures or complex risk profiles, to allocate examiner resources, and to set
examination priorities. These tools rely on Call Report data and various economic indicators
and data. To make assessments about the level of a bank's interest rate exposure, examiners
augment the insights provided by these preliminary indicators with the quantitative exposure
estimates generated by a bank's internal risk measurement systems. For most banks the
results of their internal risk measures are and will continue to be the primary factor that
examiners consider when assessing a bank's level of exposure.
On the qualitative side, examiners will continue to evaluate whether a bank follows
sound risk management practices for interest rate risk when assessing its aggregate interest
rate risk exposure and its need for capital. Such practices include, but are not limited to,
adequate risk measurement systems. Indeed, as the agencies explored various approaches for
developing supervisory risk measures, it reinforced their appreciation for the critical roles that
management and board oversight, risk controls, and prudent judgment and experience play in
the interest rate risk management process.
Banks that are found to have high levels of exposure and/or weak management
practices will be directed by the agencies to take corrective action. Such actions will include
directives to raise additional capital, strengthen management expertise, improve management
information and measurement systems, reduce levels of exposure, or a combination thereof.
JOINT AGENCY POLICY STATEMENT
PURPOSE
This joint agency policy statement ("Statement") provides guidance to banks on
prudent interest rate risk management principles. The three federal banking agencies -- the
Board of Governors of the Federal Reserve System, the Federal Deposit Insurance
Corporation, and the Office of the Comptroller of the Currency ("agencies") -- believe that
effective interest rate risk management is an essential component of safe and sound banking
practices. The agencies are issuing this Statement to provide guidance to banks on this
subject and to assist bankers and examiners in evaluating the adequacy of a bank's
management of interest rate risk3.
This Statement applies to all federally-insured commercial and FDIC supervised
savings banks ["banks"]. Because market conditions, bank structures, and bank activities
vary, each bank needs to develop its own interest rate risk management program tailored to
its needs and circumstances. Nonetheless, there are certain elements that are fundamental to
sound interest rate risk management, including appropriate board and senior management
oversight and a comprehensive risk management process that effectively identifies, measures,
monitors and controls risk. This Statement describes prudent principles and practices for each
of these elements.
The adequacy and effectiveness of a bank's interest rate risk management process and
the level of its interest rate exposure are critical factors in the agencies' evaluation of the
bank's capital adequacy. A bank with material weaknesses in its risk management process or
high levels of exposure relative to its capital will be directed by the agencies to take
corrective action. Such actions will include recommendations or directives to raise additional
capital, strengthen management expertise, improve management information and measurement
systems, reduce levels of exposure, or some combination thereof, depending upon the facts
and circumstances of the individual institution.
When evaluating the applicability of specific guidelines provided in this Statement and
the level of capital needed for interest rate risk, bank management and examiners should
consider factors such as the size of the bank, the nature and complexity of its activities, and
the adequacy of its capital and earnings in relation to the bank's overall risk profile.
BACKGROUND
Interest rate risk is the exposure of a bank's financial condition to adverse movements
in interest rates. It results from differences in the maturity or timing of coupon adjustments
of bank assets, liabilities and off-balance-sheet instruments (repricing or maturity-mismatch
risk); from changes in the slope of the yield curve (yield curve risk); from imperfect
correlations in the adjustment of rates earned and paid on different instruments with otherwise
similar repricing characteristics (basis risk -- e.g. 3 month Treasury bill versus 3 month
LIBOR); and from interest rate-related options embedded in bank products (option risk).
Changes in interest rates affect a bank's earnings by changing its net interest income
and the level of other interest-sensitive income and operating expenses. Changes in interest
rates also affect the underlying economic value4 of the bank's assets, liabilities and off-balance sheet instruments because the present value of future cash flows and in some cases,
the cash flows themselves, change when interest rates change. The combined effects of the
changes in these present values reflect the change in the bank's underlying economic value.
As financial intermediaries banks accept and manage interest rate risk as an inherent
part of their business. Although banks have always had to manage interest rate risk, changes
in the competitive environment in which banks operate and in the products and services they
offer have increased the importance of prudently managing this risk. This guidance is
intended to highlight the key elements of prudent interest rate risk management. The
agencies expect that in implementing this guidance, bank boards of directors and senior
managements will provide effective oversight and ensure that risks are adequately identified,
measured, monitored and controlled.
BOARD AND SENIOR MANAGEMENT OVERSIGHT
Effective board and senior management oversight of a bank's interest rate risk
activities is the cornerstone of a sound risk management process. The board and senior
management are responsible for understanding the nature and level of interest rate risk being
taken by the bank and how that risk fits within the overall business strategies of the bank.
They are also responsible for ensuring that the formality and sophistication of the risk
management process is appropriate for the overall level of risk. Effective risk management
requires an informed board, capable management and appropriate staffing.
For its part, a bank's board of directors has two broad responsibilities:
Senior management is responsible for ensuring that interest rate risk is managed on
both a long range and day-to-day basis. In managing the bank's activities, senior
management should:
RISK MANAGEMENT PROCESS
Effective control of interest rate risk requires a comprehensive risk management
process that includes the following elements:
The formality and sophistication of these elements may vary significantly among institutions,
depending upon the level of the bank's risk and the complexity of its holdings and activities.
Banks with non-complex activities and relatively short-term balance sheet structures
presenting relatively low risk levels and whose senior managers are actively involved in the
details of day-to-day operations may be able to rely on a relatively basic and less formal
interest rate risk management process, provided their procedures for managing and controlling
risks are communicated clearly and are well understood by all relevant parties.
More complex organizations and those with higher interest rate risk exposures or
holdings of complex instruments with significant interest rate-related option characteristics
may require more elaborate and formal interest rate risk management processes. Risk
management processes for these banks should address the institution's broader and typically
more complex range of financial activities and provide senior managers with the information
they need to monitor and direct day-to-day activities. Moreover, the more complex interest
rate risk management processes employed at these institutions require adequate internal
controls that include internal and/or external audits or other appropriate oversight mechanisms
to ensure the integrity of the information used by the board and senior management in
overseeing compliance with policies and limits. Those individuals involved in the risk
management process (or risk management units) in these banks must be sufficiently
independent of the business lines to ensure adequate separation of duties and to avoid
conflicts of interest.
Risk Controls and Limits
The board and senior management should ensure that the structure of the bank's
business and the level of interest rate risk it assumes are effectively managed and that
appropriate policies and practices are established to control and limit risks. This includes
delineating clear lines of responsibility and authority for the following areas:
In some institutions the board and senior management may rely on a committee of
senior managers to manage this process. An institution should also have policies for
identifying the types of instruments and activities that the bank may use to manage its interest
rate risk exposure. Such policies should clearly identify permissible instruments, either
specifically or by their characteristics, and should also describe the purposes or objectives for
which they may be used. As appropriate to the size and complexity of the bank, the policies
should also help delineate procedures for acquiring specific instruments, managing portfolios,
and controlling the bank's aggregate interest rate risk exposure.
Policies that establish appropriate risk limits that reflect the board's risk tolerance are
an important part of an institution's risk management process and control structure. At a
minimum these limits should be board approved and ensure that the institution's interest rate
exposure will not lead to an unsafe and unsound condition. Senior management should
maintain a bank's exposure within the board-approved limits. Limit controls should ensure
that positions that exceed certain predetermined levels receive prompt management attention.
An appropriate limit system should permit management to control interest rate risk exposures,
initiate discussion about opportunities and risk, and monitor actual risk taking against
predetermined risk tolerances.
A bank's limits should be consistent with the bank's overall approach to measuring
interest rate risk and should be based on capital levels, earnings, performance, and the risk
tolerance of the institution. The limits should be appropriate to the size, complexity and
capital adequacy of the institution and address the potential impact of changes in market
interest rates on both reported earnings and the bank's economic value of equity (EVE).
From an earnings perspective a bank should explore limits on net income as well as net
interest income in order to fully assess the contribution of non-interest income to the interest
rate risk exposure of the bank. Such limits usually specify acceptable levels of earnings
volatility under specified interest rate scenarios. A bank's EVE limits should reflect the size
and complexity of its underlying positions. For banks with few holdings of complex
instruments and low risk profiles, simple limits on permissible holdings or allowable repricing
mismatches in intermediate- and long-term instruments may be adequate. At more complex
institutions, more extensive limit structures may be necessary. Banks that have significant intermediate- and long-term mismatches or complex options positions should have limits in place that
quantify and constrain the potential changes in economic value or capital of the bank that
could arise from those positions.
Identification and Measurement
The agencies believe that a well-managed bank will consider both earnings and
economic perspectives when assessing the full scope of its interest rate risk exposure. The
impact on earnings is important because reduced earnings or outright losses can adversely
affect a bank's liquidity and capital adequacy. Evaluating the possibility of an adverse
change in a bank's economic value of equity is also useful, since it can signal future earnings
and capital problems. Changes in economic value can also affect the liquidity of bank assets,
because the cost of selling depreciated assets to meet liquidity needs may be prohibitive.
Since the value of instruments with intermediate and long maturities or embedded
options is especially sensitive to interest rate changes, banks with significant holdings of these
instruments should be able to assess the potential longer-term impact of changes in interest
rates on the value of these positions and the future performance of the bank.
Measurement systems for evaluating the effect of rates on earnings may focus on
either net interest income or net income. Institutions with significant non-interest income that
is sensitive to changing rates should focus special attention on net income. Measurement
systems used to assess the effect of changes in interest rates on reported earnings range from
simple maturity gap reports to more sophisticated income simulation models. Measurement
approaches for evaluating the potential effect on economic value of an institution may,
depending on the size and complexity of the institution, range from basic position reports on
holdings of intermediate, long-term and/or complex instruments to simple mismatch
weighting techniques to formal static or dynamic cash flow valuation models.
Regardless of the type and level of complexity of the measurement system used, bank
management should ensure the adequacy and completeness of the system. Because the
quality and reliability of the measurement system is largely dependent upon the quality of the
data and various assumptions used in the model, management should give particular attention
to these items.
The measurement system should include all material interest rate positions of the bank
and consider all relevant repricing and maturity data. Such information will generally include
(i) current balance and contractual rate of interest associated with the instruments and
portfolios, (ii) principal payments, interest reset dates, maturities, and (iii) the rate index used
for repricing and contractual interest rate ceilings or floors for adjustable-rate items. The
system should also have well-documented assumptions and techniques.
Assumptions about customer behavior and new business activity should be reasonable
and consistent with each rate scenario that is evaluated. In particular, as part of its
measurement process, bank management should consider how the maturity, repricing and cash
flows of instruments with embedded options may change under various scenarios. Such
instruments would include loans that can be prepaid without penalty prior to maturity or have
limits on the coupon adjustments, and deposits with unspecified maturities or rights of early
withdrawal.
Monitoring and Reporting Exposures
Institutions should also establish an adequate system for monitoring and reporting risk
exposures. A bank's senior management and its board or a board committee should receive
reports on the bank's interest rate risk profile at least quarterly. More frequent reporting may
be appropriate depending on the bank's level of risk and the potential that the level of risk
could change significantly. These reports should allow senior management and the board or
committee to:
The reports provided to the board and senior management should be clear, concise, and timely
and provide the information needed for making decisions.
Internal Control, Review, and Audit of the Risk Management Process
A bank's internal control structure is critical to the safe and sound functioning of the
organization generally, and to its interest rate risk management process in particular.
Establishing and maintaining an effective system of controls, including the enforcement of
official lines of authority and the appropriate separation of duties, are two of management's
more important responsibilities. Individuals responsible for evaluating risk monitoring and
control procedures should be independent of the function they are assigned to review.
Effective control of the interest rate risk management process includes independent
review and, where appropriate, internal and external audit. The bank should conduct periodic
reviews of its risk management process to ensure its integrity, accuracy and reasonableness.
Items that should be reviewed and validated include:
The scope and formality of the review and validation will depend on the size and complexity
of the bank. At large banks, internal and external auditors may have their own models
against which the bank's model is tested. Banks with complex risk measurement systems
should have their models or calculations validated by an independent source -- either an
internal risk control unit of the bank or by outside auditors or consultants.
The findings of this review should be reported to the board on an annual basis. The
report should provide a brief summary of the bank's interest rate risk measurement techniques
and management practices. It also should identify major critical assumptions used in the risk
measurement process, discuss the process used to derive those assumptions and provide an
assessment of the impact of those assumptions on the bank's measured exposure.
[This signature page relates to the joint agency policy statement, "Interest Rate Risk."]
Dated at Washington, D.C., this _______________ day of May, 1996.
Footnotes 1. Guidance to examiners identifying fundamental elements of sound risk management include: SR 93-69, "Examining Risk Management and Internal Controls for Trading Activities"; SR 95-17, "Evaluating the Risk Management and Internal Controls of Securities and Derivative Contracts Used in Nontrading Activities"; SR 95-22, "Enhanced Framework for Supervising the U.S. Operations of Foreign Banking Operations"; SR 95-51, "Rating the Adequacy of Risk Management Processes and Internal Controls at State Member Banks and Bank Holding Companies"; SR 96-10, "Risk-Focused Fiduciary Examinations," and various sections of the Federal Reserve's examination manuals including the Trading Activities Manual and the Commercial Bank Examination Manual. Return to text 2. The basic principles set forth in this guidance should also be incorporated into the policies of U.S. branches and agencies of foreign banks with appropriate adaptations to reflect the facts that: 1) those offices are an integral part of a foreign bank which should be managing its risks on a consolidated basis and recognizing possible obstacles to cash movements among branches, and 2) the foreign bank is subject to overall supervision by its home authorities. Return to text 3. The focus of this Statement is on the interest rate risk found in banks' non-trading activities. Each agency has separate guidance regarding the prudent risk management of trading activities. Return to text 4. The economic value of an instrument represents an assessment of the present value of the expected net future cash flows of the instrument, discounted to reflect market rates. A bank's economic value of equity (EVE) represents the present value of the expected cash flows on assets minus the present value of the expected cash flows on liabilities, plus or minus the present value of the expected cash flows on off-balance sheet instruments. Return to text |
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