Over the last few years, the financial industry have questioned how much interest rates will rise and to what degree institutions are prepared. Compounding this uncertainty, community banks and credit unions have tried to cope with additional pressure to ensure sustainable profitability by tightening margins and cutting back costs. In response to these pressures, institution leaders have added to their balance sheet assets with longer maturities and more options. These products serve to diversify the balance sheet and widen margins, but in doing so may increase interest rate risk (IRR).
Last week, MountainView Financial Solutions, a Situs company, produced a webinar titled Laying the Foundation for Interest Rate Risk Management. The webinar was the first in a series of IRR management webinars planned for community institutions and credit unions. During the discussion, speakers Chris Mills, Managing Director, and Madonna Ritter, Director of Analytics, defined IRR and provided examples of various types of IRR based on the source.
“Interest rate risk is inherent in the balance sheet,” said Ritter at the start of the webinar. She elaborated that IRR arises from the balance sheet through multiple points, such as:
Repricing or maturity mismatch of assets and liabilities;
Driver rate relationship mismatch;
Optionality (i.e. prepayments, rate caps and floors, CD early withdrawals, calls or puts);
Non-maturity deposit behavior;
Market and other economic factors.
She said that financial instruments, such as loans, investments, funding and equity, all contribute to IRR and each type of instrument will vary as interest rates change. For instance, fixed loans vs. variable, variable vs. adjustable, and long-term vs. short-term instruments are all building blocks of IRR and require institutions to implement effective IRR management plans.
Throughout the discussion, Ritter and Mills defined types of IRR such as repricing risk and option risk, and outlined both static and dynamic IRR measurement methodologies such as earnings-at-risk and net interest income (NII IRR) and equity-at-risk/economic value of equity (EVE or NEV).
This webinar provides an excellent foundation for the types of risk measurements and best practices that community institution or credit unions looking to expand their IRR models need to understand, capture and plan for risk and communicate that risk to their boards. You can watch the webinar by following this link, and you can register for the next three webinars in the series below:
Building Blocks for a Solid Interest Rate Risk (IRR) Management Modeling Process
Date: May 15, 2019
Time: Noon CDT
Testing the Soundness of the Structure – Interest Rate Risk (IRR) Modeling Assumptions
Date: September 28, 2019
Time: Noon CDT
How Good Interest Rate Risk Governance Ensures Against Catastrophe
Date: November 20, 2019
Time: Noon CDT
If you have any questions about the webinar series, please reach out to our credit union representative, Karen Schwall email@example.com, or our bank representative, Bertrand Laurent, firstname.lastname@example.org.