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A.

Policies and Procedures

1. Determine if the Board of Directors is effectively directing the management of interest rate risk by
evaluating its efforts in the following areas:

a) Has the Board communicated to ALM the level and exposure limits of interest rate risk it is willing to
tolerate?

b) Does the Board appropriately monitor the bank's performance and overall interest rate risk profile? Is
the Board receiving enough information to provide oversight and direction to management? Does the Board
have an adequate understanding of the current and potential impact that interest rate risk may have on the
bank's financial condition?
2. Obtain and review the interest rate risk management policy for functionality and reasonableness. Ensure:

a) That policies are in place


b) That policies are current
c) That they are approved by the Board of Directors and ALCO. In addition, document how frequently this
policy is updated, reviewed, and approved.

Also ensure that the policies include the following:

a) Limits for interest rate risk exposure. This refers to the maximum amount of rate risk exposure the
bank is willing to accept. The policy should express the bank's philosophy regarding interest rate risk
exposures and its overall goals.
Limits should be based on capital levels, earnings, performance, and the risk tolerance of the bank. Limits
should be in place for (1) counterparty exposures (considering value changes from interest rates), (2) net
income as well as net interest income, and (3) earnings and economic value at risk.

b) Responsibility of interest rate risk measurement and management. Specifics should include
departments and individuals, along with their duties and responsibilities.

c) Methods to be employed to measure and monitor interest rate risk and the frequency of rate risk
measurement.

d) Requirements to verify or ensure validity of interest rate risk measurement.

e) Acceptable and unacceptable courses of action (or instruments) for managing interest rate risk.

f) Measures taken to monitor policy compliance.

g) Measures taken when there are policy exceptions and violations

h) General requirements regarding the frequency and content of MIS reports to senior management and
the Board, regarding the size of the bank's interest rate risk exposures, including compliance with policy
limits.

i) Coordination of interest rate risk management with other departments and banking activities.

j) The responsibilities of the Board of Directors, the Rate Committee, and related committees as they
relate to the ALM process are defined.

k) New product risk review process.


3. Determine if senior management is effectively managing interest rate risk exposures by evaluating the
following:

a) Interest rate risk management practices and procedures are in concert with the Board's direction,
goals and objectives.

b) Has established responsibility and lines of authority for the measurement, management and reporting
of interest rate risk exposures.

c) Determine if any areas of potential interest rate risk exist that the bank has not identified.

d) Determine if senior management makes a commitment about the direction of interest rates and that it
is documented in ALCO minutes.

4. Review the policies pertaining to liquidity to ensure they address the following:

a) Establish responsibility and accountability for liquidity management


b) Specify desired limits and positions
c) Designate alternative funding sources
d) Are consistent with management's strategic direction and established risk tolerance levels
e) Are approved by the Board

5. Evaluate the lines of communication between the various departments of the bank. Document the means
by which key personnel become aware of ALCO strategies or monitor issues which impact the interest rate
risk exposure and liquidity management of the bank. Ensure that proper communication channels exist for
key personnel to understand the strategic direction and accurately and effectively manage interest rate risk.

6. Evaluate how the results of ALCO strategies are measured.

7. Document the members of the ALCO Committee, Rate Committee, and related committees. Prepare a
narrative on each committee detailing the role it plays in interest rate risk management.

8. Obtain and review the minutes of all ALCO and related committee meetings for the current fiscal year.
Document the frequency of these meetings and detail significant discussions held in these workpapers.
B. Risk Measurement System - Appropriateness
1. Evaluate the risk measurement system used currently by the bank through inquiry of the
following:

a) Has a risk measurement system (RMS) that captures, analyzes, quantifies and reports
interest rate risk (IRR) in a timely and comprehensive manner been established? Does the RMS
facilitate a consolidated assessment of the company's aggregate level of interest rate risk? Is
the RMS appropriate given the nature, scope and complexities of the bank's activities?

b) Does the RMS identify and measure the major sources of IRR exposure and provide
estimates of the exposures in a timely and comprehensive manner?

c) Does the RMS measure earnings-at-risk from a change in interest rates?

d) Does the RMS identify and measure significant medium-term and long-term positions?

e) Do the interest rate scenarios used to measure the potential IRR exposures:
Cover a reasonable range of rate movements in comparison with historical rate
movements?
Allow for the impact of a rate-shock of at least 200 basis points over a one-year
period?
Reflect the potential risks arising from option-related positions?
Reasonably anticipate holding periods or the time it may take to implement risk-
mitigating actions given the bank's strategies, activities, market access, and management
abilities.

f) Does a process exist for ensuring that risk positions are appropriately adjusted for
changing market conditions and that management has sufficient expertise and market access
to adjust risk levels?

g) Are internal reports prepared that serve as an adequate basis for IRR management
decisions and for monitoring the results of those decisions?

2. Determine whether the bank's management information systems provide adequate and timely
information for assessing interest rate risk exposure in t he bank's current balance sheet
positions. Consider whether information is available for all company material portfolios (loans,
investments, deposits, off-balance sheet items, lines of business, and operating subsidiaries)
including:

· Current outstanding balances, rates/coupons, and repricing indices


· Contractual maturities or repricing dates
· Contractual caps or floors on interest rates
· Scheduled amortizations and repayments
Introductory "teaser" rates
3. Determine whether the bank's method of aggregating data is sufficient for analysis purposes
given the nature and scope of the bank's interest rate risk exposures. Specifically,

- For fixed rate residential-mortgage related products, whether data from coupon distributions is
captured in sufficient detail to allow the bank to reasonably assess its prepayment and extension
risks.

- For adjustable rate residential-mortgage related products,


- whether data on periodic and lifetime caps is captured in sufficient detail to permit adequate
analysis,
- whether the effect of teaser rates as well as the type of rate indices used (current versus
lagging) has been factored into the bank's risk measurement system,
- whether data permits the bank to monitor the prepayment, default, and extension risks of the
products.
4. Determine whether the bank's MIS provides sufficient historical, trend, and customer
information to help bank personnel formulate and evaluate assumptions regarding customer
behavior. Consider, where material, whether information is available to analyze:

- Loan prepayments
- Early deposit withdrawals
- Spreads between administered rate products, such as prime-based loans and nonmaturity
deposit accounts, and market rates of interest.

C. Risk Measurement System – Data Integrity


1. Develop an understanding of the RMS inputs/outputs through documentation in a
flowchart/schematic. Identify direct and indirect data feeds to the system. Document all
management reports/outputs from the system. Document the ultimate information flow to ALCO
committee reports, 10Q and 10K filing disclosures, bank call reports, and other key management
monitoring tools.
2. Gain an understanding of ALM's reconciliation procedures. Assess the timeliness of data used.
Test through the following:

a) For all internally generated sources of data, obtain all material reconciliations of RMS data to
supporting systems/subledgers. Evaluate adequacy of documentation and review for significant
or unusual items. Agree subledger balances back to subledger and RMS balance to RMS support.
Foot reconciliations to totals thereon, noting any discrepancies.

b) For external sources of data, obtain supporting documentation to assess propriety.

c) For all data feeds, assess the level of data manipulation/calculation. On a scope basis, select
certain data feeds and recompute ALM department's calculations, noting any discrepancies.

3. Gain an understanding of the ALM department's policies with respect to the use of data
contained in "suspense" and "in process" general ledger accounts.
4. Obtain a recent ALCO committee booklet as well as other key management ALM reports (gap
reports, liquidity analyses, etc.). On a scope basis, agree amounts per reports to the RMS for the
same period. Foot to report totals thereon and note any discrepancies.
D. Risk Measurement System – Model Assumptions
1. Review procedures for the development, validation, and implementation of modeling
assumptions. Assess the frequency for which management revises/updates key assumptions.
Specifically, cover the following assumptions:

a) future rate path projection


b) correlation analyses for various bank rates
c) early withdrawal of CDs
d) growth rate assumptions (including current/new business and M&A)
e) non-maturity deposit stratification and credit card balances
f) decay rate assumptions for deposit balances,
g) optionality on mortgages, OBS positions, and embedded caps and floors,
h) discount rates used (types and sources) to derive net present values for EVE analysis, and
i) noninterest income and expense items sensitive to rate changes.

2. On a scope basis, review assumption documentation for each modeling assumption used in the
RMS. Evaluate for appropriate methodology/rationale used in each case given past history and
current conditions, and assess when the assumption was last updated.
3. Ensure that key modeling assumptions are periodically reported to senior management and
the BOD. Ensure that proper approval is documented when major assumptions are established or
changed, and at least annually after that.
4. Test the validity of the RMS calculations using the identified model assumptions by comparing
actual versus forecasted results. Assess management's level and frequency of validity testing.
5. Evaluate the comparability of ALM assumptions to current FTP assumptions in use. Refer to
FTP 12/05/01 audit report for further details. In addition, obtain the related policies and
procedures in place which define the development, implementation, review and control processes
in place across the ALM and FTP functions.
E. Risk Measurement System - Miscellaneous
1. If the bank uses a simulation model designed by an outside
vendor, determine whether:

- The models are upgraded and kept current.


- The bank's staff members understand the key methods used by
the model to generate exposure estimates.
- The bank's staff members have received sufficient training and
have sufficient documentation on the model to ensure that the bank
staff can successfully use and interpret model results.
- The bank has assessed whether the vendor can and will continue
to provide ongoing support and documentation of the model and its
methods.

2. What audit reports does the model generate, how often are they
generated, who reviews, and how is access limited/restricted?
3. Determine the process in place for data set backup of the RMS
model. How often is data backed up?