Interest Rate Risk Management at Community Banks

An analysis of regulatory guidance and expectations by financial regulators for monitoring, measuring and managing Interest Rate Risk (IRR) exposure

It is no secret that bankers have been facing historically low interest rates since the financial crisis began in earnest in 2008 with the collapse of Leaman Brothers.  These low rates coupled with the long running economic recession created an environment where bankers have struggled to maintain their margins.  Some banks decided to pursue new business lines in order to diversify its revenue stream – both interest income and non-interest income.  Along with these new business lines came risks in the form of operational, credit, liquidity, legal and reputational risks.  Some banks under took a basic strategy that was tried by banks in previous downturns: that is they extended asset maturities and/or increased bond holdings, many with embedded options, which resulted in widening spreads due to a higher level of interest rate risk.

This is particularly true in community banks (banks less than $10 billion in assets).  From information derived from the Call Reports of Condition filed from 2007 to 2011 assets maturing or re-pricing in more than three years increased from approximately 31% of total assets to approximately 38% of total assets.   Institutions extending asset maturities without a corresponding shift in liabilities are particularly exposed to rising interest rates.  Indeed, it was against this back drop which saw banks extending maturities and reaching for yield to improve their margins that the financial regulators issued an Interagency Advisory on Interest Rate Risk in 2010.  In January of 2012 the financial regulators followed this up with an interagency Advisory on Interest Rate Risk Management based on Frequently Asked Questions.

It should also be noted that Former FDIC Chairman Shelia Bair has even said “that abnormally low interest rates are creating the “mother of all bond bubbles.”  When rates eventually move up most analysts and bankers seem to agree that many banks, particularly community banks, will not be fully prepared for the turn; in fact, the risk is most pronounced in smaller community banks since they lack the management depth and staffing to properly manage their investment portfolios.  A small bank cashier or CFO wears many hats in a small bank, such as accounting, finance, and administrative functions as well as investment portfolio operations.

Based on the financial regulatory guidance issued in 2010 and 2012, I have outlined areas that should be considered when evaluating your current interest rate risk exposure and management.

The guidance makes clear that management is responsible for ensuring that board approved strategies, policies and procedures for managing IRR are appropriately executed within the designed lines of authority and responsibility.

Management also is responsible for maintaining:

The financials regulators the following elements to be part of a prudent IRR management program:

If you are interested in an independent review of your IRR management models, processes and controls, please feel to contact  We have experience with a variety of models used by community and large banks, and can recommend a  model that would be commensurate with your bank’s IRR profile.

Wes Ware, CFA, CFIRS (Kansas City) has 25 years of experience as a Senior Bank Examiner and Fiduciary Risk Management Specialist at the Federal Reserve Bank of San Francisco; a Senior Bank Examiner and Credit Risk Specialist in the Discount Window Unit of the Federal Reserve Bank of Kansas City; and a Safety and Soundness Bank Examiner at both the Office of Thrift Supervision and the Federal Home Loan Bank of Atlanta. He is a specialist in regulatory compliance; risk management; internal audit; business planning; bank lending; financial analysis; due diligence; registered investment advisors; mortgage banking subsidiaries; asset management; hedge funds; and broker dealers.

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