It should be no surprise that regulators and industry executivesare concerned about the potential for interest rate risk exposurebuilding on the credit union industry's balance sheet. We are allaware that credit unions have evolved to meet the needs of members,providing more-complicated products and services while alsoutilizing funding sources and investments which have also increasedin complexity.

The complexity of investment and funding products availabletoday means there are more opportunities for increased interestrisk exposure despite holding sufficient levels of short-termliquidity. The current low interest rate environment intensifiesconcerns regarding the issue as credit union officials grapple withrelatively low rates of return on their investments.

These factors have a potential to create a perfect stormenvironment for credit unions when combined with the significantgrowth experienced in both membership and assets and as executiveswork to find investments with adequate returns to cover creditunion operational expenses.

With that background in mind, it becomes incumbent on regulatorsand the credit union system to ensure that interest rate riskmanagement practices and the regulatory systems used to monitor theindustry keep pace with each institution's inherent risk profile.The first step in that process is to ensure that monitoring systemsbuilt into the regulatory process appropriately focus on marketrisk.

These systems not only provide increased recognition of theissue by the regulator but should also improve opportunities forstraightforward dialogue with the industry relative to interestrate risk.

Of course, dialogue between regulator and regulated is alwaysimportant. When evaluating when interest rate risk exposure becomesuntenable, honest and candid dialogue is of utmost importance toappropriately balance present day returns against futurestability.

Fortunately such a system has already been implemented. In thelate ’90s, the banking side of the Federal Financial InstitutionsExamination Council implemented the “S” or “Sensitivity to MarketRisk” component rating, changing “CAMEL” to “CAMELS.” The systemwas put forth to separate the analysis and reporting of the “L”(Liquidity) and “S” (Sensitivity) component ratings to ensure aregulatory system that monitors those two related, but sometimesdivergent, risk exposures.

While the NCUA did not institute the FFIEC's “S” component atthat time, some state agencies have recognized the importance ofadopting the system, and more continue to follow in recognition ofthe current environment.

While the perception is likely that regulators only wish toidentify institutions with problematic risk exposure and/or weakrisk management systems in this arena, I offer another importantreason for implementation of adding “S” to CAMEL.

As regulators provide reviews, it is also important that thoseinstitutions with management appropriately measuring and monitoringinterest rate risk are recognized. Finally, the complexity ofinterest rate risk management systems, and the assumptions thatdrive the models, are not always well understood by many directors.Independent reporting could help provide an avenue to increase thatunderstanding over time.

NASCUS and state regulators remain committed to ensuring notonly a safe and sound but also a viable credit union industry.Therefore, I believe it is imperative that the regulatory agenciesand our processes evolve with the industries we supervise.

Based on current conditions, the next appropriate step in thatregulatory evolution is the implementation of the “S” rating. Thebenefits of doing so would help ensure that regulatory reviews, thesystems used to monitor credit unions, and the discussions betweenregulators and industry officials are appropriate.

John Kolhoff is board chairman for NASCUS and director ofthe Office of Credit Unions at the Michigan Department of Insuranceand Financial Services. He can be reached at (517) 373-6930or [email protected].