Safety and Soundness: Interest Rate Risk

December 11, 2017

As the banking sector has experienced nearly a decade of extraordinarily low short-term interest rates and the Federal Open Market Committee continues to discuss and implement gradual rate hikes, many banks across the Tenth District are faced with challenging decisions regarding interest rate risk (IRR) management.  In the years following the Great Recession, the banking sector has experienced strong non-maturity deposit growth and a significant mix change from longer-term deposits to non-maturity funding sources.  In a continued rising rate environment, increased pricing competition, deposit mix reversion, and disintermediation are risks that could expose Tenth District banks to increased funding costs.

It is important that bank management teams and directorates effectively manage, monitor, and control IRR.  Community bank management teams should ensure a strong understanding of the institution's deposit level and mix stability.  The importance of IRR modeling assumptions around non-maturity deposits is addressed within the Federal Reserve's Supervision and Regulation (SR) Letter 10-1,  "Interagency Advisory on Interest Rate Risk."  Specifically, the letter states "Assumptions about non-maturity deposits are critical, particularly in market environments in which customer behaviors may not reflect long-term economic fundamentals, or in which institutions are subject to heightened competition for such deposits."  Banks are reminded that IRR modeling should include assumption sensitivity analysis to help determine which assumptions have the most influence on model output.  

Additional resources include: