Mitigation Strategies

A risk mitigation strategy, by definition, is taking steps to reduce the risk (the severity of the impact and/or probability of the occurrence). A credit union should have at least a general plan for how it would systematically reduce an adverse IRR exposure that goes beyond its established risk tolerance threshold.

A credit union can take many actions to mitigate its IRR exposure. The appropriate action will depend upon the level and source of the exposure. High measures of IRR elevate the degree of potential urgency with which a credit union may need to act.

To determine if an active or passive strategy is appropriate, the examiner will consider a variety of factors. Ultimately, the goal is always to minimize losses to the extent possible without creating additional risks.

Proactive strategies to de-risk (such as to sell assets or enter hedge transactions) may be necessary when risk levels are excessive or otherwise outside of risk tolerance limits. Passive strategies (for example, letting riskier assets roll off the books by allowing them to mature and reinvesting proceeds in less risky instruments) can be acceptable when the time horizon for de-risking in this manner is relatively short.

Assessing management’s culpability in their current risk position is key. If significant risk arose due to material market changes and even low-risk strategies are showing elevated risks, a more nuanced approach may be appropriate. If management embarked on a new strategic direction that was poorly considered and modeled, and that strategy led to a foreseeable elevation of risk, a more prescriptive mitigation may be required. The precision of the modeling process and general controls will also impact the choice of mitigation strategy. The better developed the model and more mature the controls, the more leeway can be given in the mitigation approach: solid models help credit unions identify and measure risks rapidly and accurately, and controls that drive reporting mean that management can make informed adjustments as conditions change.

An effective risk management program will include a systematic and timely approach to dealing with IRR measures that fall outside of policy. A credit union should avoid a “wait-and-see” strategy when holding excessive levels of IRR on its balance sheet. Losses can accumulate quickly if rates change rapidly and, at that point, reducing the risk becomes considerably more costly. Given this possibility, credit unions should generate NII and NEV simulations frequently to identify adverse exposures, and management should be adequately and properly prepared to incur the loss of necessary risk reduction when identified.

Risk mitigation is most effective when it is integrated into the credit union’s formal processes for measuring, monitoring, and managing IRR.

This topic addresses:

• Active Mitigation Strategies

• Passive Mitigation Strategies

Last updated on December 06, 2024