Why the NCUA Evaluates Credit Unions' IRR Exposure

The NCUA evaluates a credit union’s IRR exposure because IRR exposure can represent a major threat to a credit union’s earnings and capital and may have a material impact on the liquidity position when interest rates are volatile. Poorly managed IRR can present an undue risk to the Share Insurance Fund.

For a discussion of undue risk, please refer to the FCUA § 1781, Insurance of member accounts, and the definition provided in NCUA regulation § 741.3(d), Insurance of member accounts would not otherwise involve undue risk to the NCUSIF.

When elevated, IRR can threaten a credit union’s financial performance, net worth, and overall safety and soundness. This is particularly true for credit unions with more complex loan, share, and investment products that have higher degrees of optionality. In severe circumstances, IRR can result in a loss to the Share Insurance Fund: the larger the credit union, the greater loss potential.

IRR is one of seven risk categories evaluated during the NCUA’s examination process. As part of the NCUA’s supervision procedures, each of these risk areas receive a high, moderate, or low rating.

When IRR is high, supervisory oversight may be executed with increased urgency. The credit union may be required to develop and execute an adequate strategy for reducing its IRR exposure to an acceptable level. This could require the credit union to make changes to its balance sheet through hedging (using an external instrument or derivative or through intentionally shifting the asset/liability mix to better align), restructuring and/or asset disposition to keep it below the level of high for the foreseeable future, and to do so within a reasonable time. High IRR exposure can occur when a credit union’s starting level of capital is significantly lower than the industry average and is coupled with a material amount of IRR exposure. Additionally, weak risk management practices can limit the ability to identify, measure, monitor, and control the IRR position, resulting in elevated risk. It is important to remember that this means either the risk level or risk management practices can lead to a high rating.

The following figure illustrates the potential supervisory action related to a credit union’s IRR rating. As a credit union’s IRR level increases, supervisory expectations for management increase as well.

image with text. When IRR Ratings are low, the supervisory expectation is to follow routine examination processes. When IRR ratigns are moderate, supervisory expectation is to follow routine examination processes. When IRR ratings are high, there are: higher management expectations, the credit union may be unsafe and unsound, the credit unionw will likely be under hightened to close supervision, and a DOR may be needed on a case-by-case basis and supervisory action may be necessary.

NCUA regulations part 741, Appendix A, Guidance for an Interest Rate Risk Policy and an Effective Program, provides information to assist credit unions in determining the adequacy of their IRR policy and the effectiveness of their program to manage IRR. These guidelines serve as the basis for this section of the Examiner's Guide and the IRR Workbook Procedures job aid.

Last updated on December 06, 2024