Interest Rate Risk and Liquidity Risk Management · Overview •Interest Rate Risk - What is IRR? -...

Interest Rate Risk and Liquidity Risk Management

© 2014 Elliott Davis, PLLC © 2014 Elliott Davis, LLC

Mark F. Rufail Senior Manager

This material was used by Elliott Davis during an oral presentation; it is not a complete record of the discussion. This presentation is for informational purposes and does not contain or convey specific advice. It should not be used or relied upon in regard to any particular situation or circumstances without first consulting the appropriate advisor. No part of the presentation may be circulated, quoted, or reproduced for distribution without prior written approval from Elliott Davis.

2 © 2014 Elliott Davis, PLLC © 2014 Elliott Davis, LLC

Overview

• Interest Rate Risk - What is IRR? - Current Regulatory Focus - Internal Control System - Independent Review and Validation

• Liquidity Risk Management - Internal Control System - Independent Review and Validation


What is IRR?

• Banks are in the business of managing IRR - Repricing Risk: timing differences between coupon

changes or cash flows of assets and liabilities - Yield Curve Risk: non-parallel changes in yield curve - Option Risk: cash flows change with embedded

options (prepayment/extension, call options, runoff) - Basis Risk: different indices with same maturity move

at different pace


Current Regulatory Focus

• Margin pressure is hindering meaningful earnings recovery

• Increases in long-term asset exposure to support yield coupled with surge in non-maturity deposits

• Fear of substantial deposit runoff (surge deposits and parked funds)

• Examiner focus on assumptions, sensitivity analysis, internal controls/validation


Margin Pressure


Source: FDIC “Interest Rate Risk Overview & Recent Industry Trends” Call Reports & TFRs. Based on median figures of all institutions under $1B in assets

Long-Term Exposure


Share of Banks with Long-term Assets Representing 30% or More of Earning Assets

Source: FDIC “Interest Rate Risk Overview & Recent Industry Trends” Call Reports. Based on consistent sample of active Call Filers as of 4Q12 with assets < $1B. Excludes any former TFR filers

Internal Control System

• Board established system of internal controls - Corporate governance - Compliance with policies and procedures - Comprehensive measurement system


Effective Control Structure

• Roles, responsibilities, and authority • Adequate segregation of duties • Inputs and measurements are accurate and complete • Policy compliance • Independent review and validation • Management response and follow-up • Size, nature, and complexity of institution should be

incorporated in evaluating all aspects


Adequacy and Compliance of Control System

• Review/Test - Lines of authority - Segregation of duties - Corrective actions - Compliance with risk limits

• Ensure staff compliance with procedures


Data Inputs

• Data Integrity - Is data accurate, complete, and useful? - Source of data

• Data Input Controls - Automatic vs. Manual input - Reconciliation and review process

• Test Data Inputs - Balance sheet - Budgets/forecasts - Assumptions


Assumptions

• Reasonableness - Can compare to historical and current data

• Documentation - Understandable format and includes all assumptions

• Sensitivity analysis - Which factors are most important? (Stress Testing)

• Sufficiency of modeled scenarios - Reasonable range of rate changes and models

• Board approval and understanding


Validation

• Internal Models - Significant amount of time required for validation

process. - Includes validation of model mechanics and

mathematics. • External Models

- Vendors normally provide validation results. Management should review and assess at least annually.


Backtesting

• Compare Modeled vs. Actual Results - Static vs. Dynamic modeling for NII sensitivity

• Were assumptions accurate? - If not, has management identified changes for future

modeling? • Identify causes of differences


Reporting

• Perform annually and report to Board/Audit Committee

- Testing details - Findings summary - Key assumptions - Management’s responses


IRR Guidance

• FIL-52-96 - Joint Agency Policy Statement on Interest Rate Risk - http://www.fdic.gov/news/news/financial/1996/fil9652.html

• FIL-2-2010 - Financial Institution Management of Interest Rate Risk

- http://www.fdic.gov/news/news/financial/2010/fil10002.html

• FIL-2-2012 - Interest Rate Risk Management: Frequently Asked Questions - http://www.fdic.gov/news/news/financial/2012/fil12002.html

• FIL-46-2013 - Managing Sensitivity to Market Risk in a Challenging Interest

Rate Environment - https://www.fdic.gov/news/news/financial/2013/fil13046.html


http://www.fdic.gov/news/news/financial/1996/fil9652.html



https://www.fdic.gov/news/news/financial/2013/fil13046.html

Liquidity Risk Management

• What is Liquidity Risk? - The risk that an institution's financial condition or

overall safety and soundness is adversely affected by an inability (or perceived inability) to meet its obligations.


Types of Liquidity Risk

• Funding mismatches • Market constraints on the ability to convert assets

into cash or in accessing sources of funds • Contingent liquidity events • Changes in economic conditions • Exposure to credit, market, operation, legal, and

reputation risks


Internal Control System

• Policies and Procedures • Risk Identification • Risk Management • Reporting • Compliance with applicable rules and regulations • Independent Review and Evaluation


Independent Review and Evaluation

• Assess compliance with supervisory guidance and industry practices

- Corporate governance - Policies, procedures, and risk tolerances - Monitoring and reporting - Diversification of funding and sources - Contingency funding plan


Testing

• Compliance with supervisory guidance - Interagency Policy Statement on Funding and Liquidity

Risk Management • http://www.fdic.gov/regulations/laws/rules/5000-5230.html

- FIL-84-2008 – Liquidity Risk Management • http://www.fdic.gov/news/news/financial/2008/fil08084.html


http://www.fdic.gov/regulations/laws/rules/5000-5230.html


Q & A


Questions?

Mark F. Rufail Email: [email protected] Phone: 803.255.1484 Website: www.elliottdavis.com

Elliott Davis, LLC/PLLC is one of the largest accounting, tax and consulting services firms in the Southeast and ranks among the top 50 CPA firms in the U.S. With offices in SC, NC, GA and VA, the firm provides clients across a wide range of industries with smart, customized solutions and its people with rewarding opportunities. Founded in 1925, Elliott Davis is a member of The Leading Edge Alliance, an international professional association of independently owned accounting firms based in the U.S. and is strategically aligned with LEA Europe and LEA Asia Pacific, a worldwide network of more than 450 offices in 100 countries around the globe. For more information about Elliott Davis and its services, visit http://www.elliottdavis.com.


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