May 22, 2017
Several years ago, a bank director was quoted as saying “Being a bank director is like being a pilot of an aircraft. It’s years of boredom and seconds of terror.” And while that may have been true at the time, the quote from Yogi Berra, “The future ain’t what it used to be,” speaks to the state of banking today, including the increasing responsibility of community bank boards of directors. In today’s banking space, every bank director has to be confident they understand their overarching responsibility, part of which includes comprehending and overseeing the bank’s exposure to fluctuating interest rates.
Exposed to Risk
Given banks are in the business of investing short-term deposits in long-term loans, they are inherently exposed to some degree of interest rate risk (IRR). This warrants a risk management program enabling the bank’s directorship and management team to effectively identify, measure, monitor and control this exposure. The diligence and resources devoted to this program should be consistent with the risk and complexity of the bank’s asset and liability mix.
While there are IRR management practices all banks should prudently implement, community banks are not necessarily required to have the same level of sophisticated practices mandated at larger, more complex banking organizations. The graphic below highlights the four fundamental elements for every institution’s IRR management program:
Four key elements of a risk management program for interest rate risk
What Directors Need to Know
While many community bank directors have limited exposure to IRR in their own professional careers, they—more than ever—need to have a basic knowledge of the key elements. A few of these elements include understanding the various types of IRR, how the bank’s balance sheet activities can impact its IRR exposure, and how risk measurement reports are used to identify risk exposure. Having this background enables the board to establish quality policies, risk limits, and management governance systems, which results in its effective oversight of IRR.
Directors Bear Responsibility
Although the responsibility of measuring and monitoring risk can be delegated to bank management and/or board committees (such as an asset/liability management committee or ALCO), all board members are held accountable for the institution’s IRR in the eyes of the regulatory bodies. As part of the examination process, bank examiners assess the board’s engagement in all of the bank’s risk management activities, including IRR. This evaluation encompasses the board’s capacity to appropriately define its risk tolerance, establish appropriate IRR controls, allocate resources to executing established risk management strategies, and hold senior management accountable for implementing board-approved policies.
In light of the current interest rate environment and greater regulatory pressure to have effective practices in place for managing IRR, it’s increasingly important for you, as board members, to understand how and when rate changes begin to impact your bank’s fi condition. To accomplish this, your bank needs an IRR risk management program that allows you and your senior management team to be proactive rather than reactive to rate changes.
Doing nothing is no longer a sustainable strategy in today’s banking industry, but making dramatic changes to your current IRR strategy isn’t necessarily required either. With a sound oversight structure in place, you can effectively steer the bank through whatever challenges may lie ahead.