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Supervisory Committee is Key to Interest-Rate Risk Oversight
Thursday, December 10, 2015 6:40 AM

With the Federal Reserve likely to raise interest rates next week for the first time since before the Great Recession, supervisory committees need to be acutely aware of how prepared their credit unions are and how they will react.

That was the message from BKD’s Mike Ososki when he presented “How to Make Your Interest-Rate Risk (IRR) Model Relevant” to the CUNA Supervisory Committee and Internal Audit Conference in Las Vegas Tuesday.

Management has the responsibility to develop IRR strategies and a program that considers:

  • Size, nature, and scope of risk activities;
  • Board-approved risk tolerances;
  • Board strategies; and
  • Limiting the risk to earnings and capital of the credit unions.

“The supervisory committee needs to ensure that it oversees the appropriate policies, controls and procedures over IRR by using the internal audit program or senior management oversight based upon the institution’s risk profile,” he said.

Capital gap analysis, earnings simulation analysis, and economic value of equity are prevalent types of measurement methods to capture and quantify exposure to earnings and capital. Stress testing is an integral part of IRR management. It should assess a range of scenarios such as:

  • An instantaneous rate change (rate shock) of 100- to 400-basis point increase and decrease;
  • Significant rate changes over time (rate ramp) of 300 basis point risk over 24 months;
  • Substantial rate changes over time;
  • Changes in key market rates (e.g., prime); or
  • Changes in shape or slope of yield curve.

“The supervisory committee needs to make sure that stress testing is being done and is being reported to the board on a regular basis,” Ososki said.

Model assumptions must accurately reflect management’s expectations regarding interest rates, consumer behavior, and local and macro-economic factors. The assumptions must be regularly updated and supported through analysis and documentation. “When you’re using models, make sure you have good, documented due diligence on the process,” he said.

“IRR modeling has to be commensurate with a credit union’s size and complexity,” he said, adding that the most crucial parts of model assumptions must accurately reflect management’s expectations.