A Sensitive Focus on Interest Rate Risk
It should be no surprise that regulators and industry executives are concerned about the potential for interest rate risk exposure building on the credit union industry's balance sheet. We are all aware that credit unions have evolved to meet the needs of members, providing more-complicated products and services while also utilizing funding sources and investments which have also increased in complexity.
The complexity of investment and funding products available today means there are more opportunities for increased interest risk exposure despite holding sufficient levels of short-term liquidity. The current low interest rate environment intensifies concerns regarding the issue as credit union officials grapple with relatively low rates of return on their investments.
These factors have a potential to create a perfect storm environment for credit unions when combined with the significant growth experienced in both membership and assets and as executives work to find investments with adequate returns to cover credit union operational expenses.
With that background in mind, it becomes incumbent on regulators and the credit union system to ensure that interest rate risk management practices and the regulatory systems used to monitor the industry keep pace with each institution's inherent risk profile. The first step in that process is to ensure that monitoring systems built into the regulatory process appropriately focus on market risk.
These systems not only provide increased recognition of the issue by the regulator but should also improve opportunities for straightforward dialogue with the industry relative to interest rate risk.
Of course, dialogue between regulator and regulated is always important. When evaluating when interest rate risk exposure becomes untenable, honest and candid dialogue is of utmost importance to appropriately balance present day returns against future stability.
Fortunately such a system has already been implemented. In the late ’90s, the banking side of the Federal Financial Institutions Examination Council implemented the “S” or “Sensitivity to Market Risk” component rating, changing “CAMEL” to “CAMELS.” The system was put forth to separate the analysis and reporting of the “L” (Liquidity) and “S” (Sensitivity) component ratings to ensure a regulatory system that monitors those two related, but sometimes divergent, risk exposures.
While the NCUA did not institute the FFIEC's “S” component at that time, some state agencies have recognized the importance of adopting the system, and more continue to follow in recognition of the current environment.
While the perception is likely that regulators only wish to identify institutions with problematic risk exposure and/or weak risk management systems in this arena, I offer another important reason for implementation of adding “S” to CAMEL.
As regulators provide reviews, it is also important that those institutions with management appropriately measuring and monitoring interest rate risk are recognized. Finally, the complexity of interest rate risk management systems, and the assumptions that drive the models, are not always well understood by many directors. Independent reporting could help provide an avenue to increase that understanding over time.
NASCUS and state regulators remain committed to ensuring not only a safe and sound but also a viable credit union industry. Therefore, I believe it is imperative that the regulatory agencies and our processes evolve with the industries we supervise.
Based on current conditions, the next appropriate step in that regulatory evolution is the implementation of the “S” rating. The benefits of doing so would help ensure that regulatory reviews, the systems used to monitor credit unions, and the discussions between regulators and industry officials are appropriate.
John Kolhoff is board chairman for NASCUS and director of the Office of Credit Unions at the Michigan Department of Insurance and Financial Services. He can be reached at (517) 373-6930 or email@example.com.