Interest rate risk refers to the current and prospective risk to a credit union’s capital and earnings arising from movements in interest rates. When interest rates change, the present value and timing of future cash flows may change. This, in turn, changes the underlying value of a credit union’s assets, liabilities, and off-balance-sheet items and thus its overall net economic value. Changes in interest rates also affect a credit union’s earnings by altering interest rate-sensitive income and expenses, which affects its net interest income. Excessive IRR can present a significant threat to a credit union’s current capital and projected earnings if not managed appropriately.
IRR is a potentially significant risk that arises from credit union activities, and it is inherent to some degree in all credit unions. The risk arises because interest rates can vary significantly over time, while the credit union business typically involves activities that produce exposures to maturity mismatch (for example, long-maturity assets funded by short-maturity liabilities) or rate mismatch (such as fixed-rate loans funded by variable-rate shares/deposits). In addition, there are embedded options in many of the typical credit union balance sheet items (such as non-maturity shares, term deposits, mortgage loans, and investments) that could be triggered with changes in interest rates.
In January 2010, the FFIEC emphasized the importance of effective governance, policies and procedures, risk management and monitoring systems, stress testing, and internal controls related to IRR exposures. The advisory indicates financial institutions should manage IRR commensurate with their complexity, risk profile, business model, and scope of operations.
In 2012, the FFIEC issued supplemental guidance addressing Frequently Asked Questions:
FFIEC Advisory on Interest Rate Risk Management (January 6, 2010)
Letter to Credit Unions 10-CU-06, Interagency Advisory on Interest Rate Risk Management
FFIEC Interagency Advisory on Interest Rate Risk Management - Frequently Asked Questions (January 12, 2010)
In addition to the FFIEC advisories, the NCUA has emphasized the importance of IRR management in numerous communications and, notably, in:
Letter to Credit Unions 99-CU-12, Real Estate Lending and Balance Sheet Risk Management
Letter to Credit Unions 03-CU-15, Real Estate Concentrations and Interest Rate Risk Management for Credit Unions with Large Positions in Fixed Rate Mortgages
Letter to Credit Unions 12-CU-05, Interest Rate Risk Policy and Program Requirements
NCUA regulation Part 741, Appendix A, Guidance for an Interest Rate Risk Policy and an Effective Program (rule applies to all federally insured credit unions with assets equal to or greater than $50 million) (January 2012)
This section of the Examiner's Guide addresses the following topics:
- Why NCUA evaluates a credit union’s IRR exposure
- Types and sources of IRR
- How IRR relates to other risks
- Exam Procedures
ALM is the process of evaluating, monitoring, and controlling changes in a credit union’s market and balance sheet risk. These risks can adversely affect earnings and capital adequacy. Examiners’ evaluation of a credit union’s ALM is reflected in the “L” component of the CAMELS rating. (Letter to Credit Unions 22-CU-05, CAMELS Rating System)
Workpapers & Resources
- NCUA regulation Part 741, Appendix A, Guidance for an Interest Rate Risk Policy and an Effective Program
Last updated October 11, 2016