Since the release of the 2010 Advisory on Interest Rate Risk Management, the Federal Financial Institutions Examination Council (FFIEC) has received numerous questions on several key issues mentioned in the guidance.
In January, 2012, the FFIEC released a response to the Frequently Asked Questions (FAQs), hoping to clear up some of the confusion. The following are restatements of a few important points mentioned in the 2010 Advisory:
- In a low-rate environment, institutions should run interest rate shocks of +300 and +400 basis points. If conditions warrant, institutions should test more severe scenarios.
- Management should use reporting limits, triggers, or thresholds for stress scenarios, including the severer rate shocks discussed above, and others where appropriate to ensure IRR exposures are within risk tolerance levels.
- Management should perform simulations for one and two year time horizons, conduct model measurements that do not include new business growth, develop reasonable assumptions reflecting the institution’s experience, and perform appropriate back-testing.
- Smaller institutions using less complex vendor-supplied IRR models can satisfy some, but not all, validation requirements with independent attestation reports from the vendor.
In addition, the report clarified two key issues that were the cause of a great deal of confusion.
- Validation & Internal Controls – independent certifications/validations commissioned by model vendors do not satisfy all supervisory expectations. Institutions should secure a review of the entire range of ALCO processes from a sufficient independent party, which includes the various elements of their IRR management processes.
- Assumptions (Non-Maturity Deposits) – Industry estimates or defaults provide only an approximation and should be viewed as a starting point for further analysis.