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Proposed IRR Regulation Could Have Unintended Consequences

C. myers agrees with the objective that most institutions should have an effective interest rate risk (IRR) management policy supported by an effective IRR program.  However, we do not agree that it should be regulation.

Keep in mind as you read our comments that our business is to provide asset/liability management services to financial institutions.  We have worked with hundreds of credit unions providing long-term risks to earnings and net worth simulations, static and dynamic balance sheet analyses and net economic value (NEV) simulations.  A regulation of this nature would likely materially increase our business opportunities, yet we do not believe it is in the best, long-term interest of the industry.

One primary reason that we do not support the proposed regulation is that it is ambiguous.  We understand this ambiguity is necessary.  However, ambiguity will lead to subjectivity when implementing the regulation.  Whether a credit union has a written policy with adequate limits and an effective program addressing IRR may ultimately be determined by each credit union’s most recent examiner.

Please click here to read our full response to the proposed IRR regulation.

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Caution: NCUA’s Proposed Regulation On IRR Could Have Unintended Consequences

You think you are already doing everything required in the proposed Regulation.  You think your policy limits are appropriate for your strategy and business model—but will the examiner making the judgment as to whether your credit union is in compliance think the same?

NCUA’s proposed shift from Advisory to Regulation is concerning.

It raises several questions, such as:

  • What power will NCUA gain that they don’t currently have by implementing a Regulation on IRR management?
  • How will NCUA change their approach in the exam process once this Regulation is implemented?  If NCUA says there will not be a significant change in their approach, then why is there a proposal to shift from Advisory to Regulation?  In other words, what problem is NCUA trying to correct?
  • If the board believes the policy limits are adequate and they are managing to those limits, yet the examiner believes otherwise, will the credit union be deemed out of compliance with Regulation?
  • If so, what are the credit union’s options under this new Regulation?  Specifically, what options or control will the credit union no longer have once the Regulation is implemented?
  • Under the umbrella of the Regulation, will the examiner be able to require the credit union to conduct additional analyses or else be deemed out of compliance, even if the credit union feels the cost/benefit would not exist?

We agree with much of the underlying intent of the proposed Regulation.  We also agree with NCUA that it is impossible to establish specific regulatory requirements.  Therefore, by necessity, the proposed Regulation is ambiguous.  Ambiguity creates confusion and will make the Regulation difficult to reasonably implement.

If there is no identified, compelling reason to go from an Advisory to Regulation, then why do it?

Keep in mind as you contemplate our comments that our business is to provide asset/liability management services to financial institutions.  A Regulation of this type could greatly enhance our business opportunities, yet we believe that NCUA shifting from an Advisory position to a Regulation is wrought with undesirable, unintended consequences.

To read our full response, please click here.

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Proposed Interest Rate Risk Regulation

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Newly proposed regulations would require federally insured credit unions to not only have an effective interest rate risk management program, but also a written policy addressing interest rate risk management.  The NCUA has taken this step due to concerns about the level of interest rate risk being taken by many institutions, as material concentrations in long-term, fixed-rate assets continue to be booked in this historically low rate environment—funded largely by short-term deposits.

Most often, managements and boards establish limits at the category or portfolio level, not at the enterprise/aggregate level.  It is not uncommon to see a credit union within their individual category or portfolio levels, yet have a relatively high level of risk at the enterprise level.  In other words, the combination of the individual risks can create an undesirable, aggregate risk profile.  Therefore, agreeing on and managing to aggregate risk levels is a key component of an effective risk management process.  However, establishing aggregate risk limits that make sense from a business perspective, as well as from a safety and soundness perspective, requires in-depth discussions and critical thinking.

These limits can also be a critical driver of financial success both today and as rates change.  So take your time and think it through.

While we believe it is prudent for decision makers to establish enterprise/aggregate risk limits, it is not intended as an endorsement for the proposed regulation.  We will write more on the proposed regulation soon.