Interest-Rate Risk

Sections in this Topic

Overview
Board and Management Responsibilities
Explanation of the Fed Perspective
Three Fundamental Issues to Address with ANY Model
What Should Drive a Bank's Model Decision?
Main Page for Manage Transition

Overview

Interest-rate risk is the risk that changes in interest rates will affect an institution's earnings or economic value. Interest-rate risk is evaluated by safety and soundness examiners under the "S," or Sensitivity to Market Risk, component of the interagency bank rating system, known as CAMELS. Many minority bank and de novo bank officials have indicated that interest-rate risk is a critical element that should be managed well.

Board and Management Responsibilities

The bank's board of directors and senior management are responsible for providing effective oversight and ensuring that risks are adequately identified, measured, monitored, and controlled. The board and senior management are responsible for understanding the nature and level of interest rate risk being taken by the bank and how that risk fits within the bank's overall business strategies.

Explanation of the Fed Perspective

The bank's modeling process for interest-rate risk should produce reasonably accurate risk measures that capture all risks material to the institution and provide clear and useful information to senior management and the board of directors. Remember this quote: "Risk cannot be managed unless its sources are identified and its magnitude measured."

Three Fundamental Issues to Address with ANY Model

What are the material interest-rate risks?
Does it measure what it says it does?
Are risk limits reasonable?

What Should Drive a Bank's Model Decision?

Banks should consider several key elements when deciding which risk model to use. For example, the complexity of the bank and its organizational structure along with the products and services the bank offers are essential factors to consider. The materiality of risk and the level of exposure to risk factors are also key elements. Finally, the benefit versus the cost of implementation is an important consideration.

Review Interest-Rate Risk in Grow Shareholder Value for examples of safe and sound practices.