ABA Banking Journal - February 2010 - (Page 28)
BALANCE SHEET MANAGEMENT Rate risk making you (or your regulator) ill? Try this four-step remedy. It could calm the regulators and set you up nicely for the recovery O ver a very short period of time since November 2009, banks of all sizes have intensified their focus on measuring, understanding, and mitigating exposure to rising rate risk. A recent symposium on the topic hosted by the FDIC attracted several hundred bankers. A conference call on the topic hosted by Sandler O’Neill in January attracted over 450 registrations. Why the sudden interest? As is most often the case, the bank regulators focused their attention on the issue, and bankers then followed suit. In light of this, the timing is right for us to outline the reasons for the scrutiny, and explore the symptoms, sources, and remedies for exposure to rising interest rates. Why all the hullabaloo? As early as spring of 2008, regulators at the OCC began raising the alarm in various public settings that exposure to rising interest rates was the “next big thing” in terms of systemic risk in the banking system. During the current rate cycle, the Federal Reserve has reduced the Fed Funds “target” rate by 525 basis points and held it there. Here early in 2010 we find ourselves with historically low short-term rates and an extremely steep yield curve despite longerterm interest rates being near historic lows. Concerned that this rate environment encourages banks to take excessive risk to rising rates By Raymond E. Chandonnet, principal, Sandler O’Neill & Partners, New York firstname.lastname@example.org by “playing the curve,” the FDIC published an article on the topic in their Winter 2009 issue of Regulatory Insights. In this article, the FDIC made the following points: • Rising rate risk has increased sharply particularly at “small” banks, defined as banks with less than $10 billion in assets; • A meaningful percentage of regulatory orders implemented in 2009 contained specific provisions requiring the bank to reduce exposure to rising rates; • Regulators consider it a best practice for banks to model interest rate risk changes at least +400 basis points, instantaneously, with a “zero growth” (static balance sheet) assumption; • It is also considered a best practice to increase loan default assumptions on floating-rate loans in a sharply rising rate environment; • Banks are encouraged to actively manage their interest rate-risk position through IRR mitigation strategies; • Banks are encouraged to make use of hedging strategies involving interest rate derivatives to help reduce interest rate risk. This was followed up by a joint directive on the topic issued by all the bank and credit union regulators on January 7th which reinforced the points made by the FDIC, focused particularly on market-value deterioration due to rising rates, and encouraged banks to increase their capital position as a buffer (as if they needed one more source of pressure to increase capital!) Article continues on page 30 Has there been a better time to lock in long-term funding? 12.00 10.00 8.00 6.00 4.00 2.00 0.00 Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. Nov. 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 5 year swaps 28 February 2010/ABA BANKING JOURNAL Subscribe at www.ababj.com
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