New Credit Union Interest Rate Regulations

This past February, the National Credit Union Administration issued a final ruling in the Federal Register that mandated all federally insured credit unions “develop and adopt a written policy on interest rate risk management and a program to effectively implement that policy…” The notification discussed the background and rational behind the new rulings, as well as detailed aspects of an effective interest rate risk policy and guidance for monitoring, measuring, and oversight of interest rate risk. The following summarizes, and where appropriate, expands upon, the key points of the NCUA issue, which goes in to effect on September 30, 2012.

Why Focus On Interest Rate Risk

Interest rate risk (IRR) is one of the primary risk factors that credit unions have to plan for and monitor. First, changes in interest rates affect earnings through their influence on interest rate sensitive assets, such as loans and securities, and interest rate sensitive liabilities, such as share deposits. Second, changes in earnings on the income statement flow through to the balance sheet and affect capital levels. If your credit union isn’t able to effectively monitor and control this risk, both earnings and capital could be hit simultaneously.

National Credit Union Administration Guidance

• IRR Policy – Among the objectives of an IRR Policy are to delegate responsibilities, identify risks, set risk tolerance limits, and specify methods to monitor and control IRR. For example, when setting risk tolerance limits, a credit union may decide it doesn’t want its Net Economic Value to decrease more than 20% for a +/-200 basis point shock/ramp. Similar limits should also be set for net interest income. If simulations indicate that the credit union is out of policy, action may need to be taken by the board or management to correct this violation.
• IRR Oversight and Management – Both the board of directors and senior management have primary roles in these areas. It is up to the board to approve the policy and the limits, as well as oversee that management carries out the IRR program that is outlined in the policy. It is up to senior management to implement the use of risk management models and evaluate their results. Central to these objectives are continuous education/training for board members and management, especially in areas where they may lack experience or expertise.
• IRR Measurement and Monitoring – An effective IRR measurement system should give a quantitative report on exposures to IRR. In using models/simulations, management is responsible for obtaining proper input data, which includes developing reasonable assumptions in areas such as deposit decay rates, deposit betas, and loan prepayment speeds. Industry benchmarks are available as inputs, but bank-specific data often results in a more effective model. Interest Income, Net Economic Value, and Gap Analysis are reports that regulators look for.
• Internal Controls – A key facet of internal controls is to separate the responsibilities of risk taking and risk measurement. In other words, the employees who take risk should not be the ones who also measure risk. Additionally, if your institution does not have the staff available to monitor the IRR program, it is acceptable to use a third party to perform duties such as: updating the investment policy, monitoring policy compliance, and reviewing reports on a regular basis.
• Decision Making Informed by IRR Measurement Systems – It is important to view the IRR Policy and IRR reports as more than just something necessary to appease regulators. Instead, management should use these as a way to improve decision making and proactively develop strategies. For instance, if IRR simulations indicate an unacceptably high level of risk in certain situations, executives may need to make adjustments to the business strategy to correct for this.

Every credit union is different in terms of size, complexity of the balance sheet, and business strategy, which means that there is no cookie-cutter template that will be appropriate for each institution. Instead, it is important for each individual credit union to examine its own unique situation when developing an IRR Policy and IRR oversight program.