In January, the Federal Financial Institutions Examination Council (FFIEC) issued responses to frequently asked questions about the agency’s 2010 Advisory on Interest Rate Risk (IRR) Management.
Four primary highlights of this guidance, according to Jeffrey Caughron, associate partner for The Baker Group, are:
1. 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.
2. Management should use reporting limits, triggers, or thresholds for stress scenarios, including severe rate shocks (and others where appropriate) to ensure IRR exposures are within risk tolerance levels.
3. Management should perform simulations for one- and-two year time horizons, conduct model measurements that don’t include new business growth, develop reasonable assumptions reflecting the institution’s experience, and perform appropriate back-testing.
4. Smaller institutions using less complex, vendor-supplied IRR models can satisfy some, but not all, validation requirements with independent attestation reports from the vendor.
“All of this is welcome confirmation of our earlier reading and understanding of the advisory,” Caughron says. “There are also some notable clarifications that we find helpful in refining our recommendation to clients. One of those points is that earnings simulation analysis for horizons longer than two years, though useful, is generally not necessary for typical institutions.”