The first half of 2022 experienced the sharpest increase in interest rates in decades.1 A sharp rise in interest rates may amplify market risk exposure to earnings and capital. This occurs because a credit union’s assets and liabilities do not reprice equally or concurrently. This timing (or duration) mismatch, combined with a sharp rise in interest rates, may result in sharply lower net economic values (NEV) as measured using the NCUA’s NEV Supervisory Test (NEV Test) or the Estimated NEV Tool (ENT).This letter revises the risk management expectations for credit unions over $50 million in assets described in Letter to Federally Insured Credit Unions 16-CU-08, Revised Interest Rate Risk (IRR) Supervision, effective January 1, 2017. This letter provides additional information and updates to the NCUA’s supervisory framework of interest rate risk (IRR).2Due to the changing economic and interest rate environments during 2022, the NCUA reviewed the parameters and risk classifications of the NEV Test and overall IRR supervisory framework. As a result of this review, several updates are being made with the issuance of this letter. Part II of this letter describes these changes in more detail.In summary, these changes include:Revising the risk classifications by eliminating the extreme risk classification and modifying the high risk classification;Clarifying when a Document of Resolution (DOR) to address IRR is warranted, including removing any presumed need for a DOR based on an IRR supervisory risk classification and related need for a credit union to develop a de-risking plan;Providing examiners more flexibility in assigning IRR supervisory risk ratings; andRevising examination procedures to incorporate updated review steps when assessing how a credit union’s management of IRR is adapting to changes in the economic and interest rate environment.Exam staff should refer to the Examiner’s Guide for more information on examining and supervising IRR. If there is a conflict between the National Supervision Policy Manual (NSPM), the Examiner’s Guide, and this letter, exam staff must rely on this letter until the NSPM, and Examiner’s Guide are updated.3 This letter is intended to supplement existing resources on the supervision of IRR; it does not replace or supersede applicable laws and regulation.Exam staff must remember that IRR is a major area of risk and, under certain market conditions, may expose credit unions to other related issues, such as liquidity risk, asset quality deterioration, unexpected losses to earnings, capital erosion, and strategic risk. The credit union system has experienced significant growth in complexity over the past two years with total assets growing by approximately 25 percent. As the system has grown, concentrations in longer maturity assets have significantly increased sensitivity to changes in interest rates.4If you have any questions regarding the changes detailed in this letter, please direct them to your immediate supervisor.I. BackgroundReview of a credit union’s IRR exposure has been a long-standing supervisory priority and part of the NCUA’s supervision program. Over the past decade, the NCUA has enhanced examination tools and issued periodic updates related to IRR for both staff and credit unions.In 2012, the NCUA updated section 741.3(b) of the NCUA regulations to require credit unions with assets greater than $50 million to maintain a written policy and an effective IRR management program as part of asset liability management.5 The regulation includes Appendix A, which provides guidance for an IRR policy and an effective program.The NCUA finalized derivatives rules providing more flexibility for federal credit unions to manage IRR in 2014 and revised the rules in 2021.6 The 2021 rule modernized the use of derivatives with a principles-based approach while retaining key safety and soundness components.
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The first half of 2022 experienced the sharpest increase in interest rates in decades.1 A sharp rise in interest rates may amplify market risk exposure to earnings and capital. This occurs because a credit union’s assets and liabilities do not reprice equally or concurrently. This timing (or duration) mismatch, combined with a sharp rise in interest rates, may result in sharply lower net economic values (NEV) as measured using the NCUA’s NEV Supervisory Test (NEV Test) or the Estimated NEV Tool (ENT).
This letter revises the risk management expectations for credit unions over $50 million in assets described in Letter to Federally Insured Credit Unions 16-CU-08, Revised Interest Rate Risk (IRR) Supervision, effective January 1, 2017. This letter provides additional information and updates to the NCUA’s supervisory framework of interest rate risk (IRR).2
Due to the changing economic and interest rate environments during 2022, the NCUA reviewed the parameters and risk classifications of the NEV Test and overall IRR supervisory framework. As a result of this review, several updates are being made with the issuance of this letter. Part II of this letter describes these changes in more detail.
In summary, these changes include:
- Revising the risk classifications by eliminating the extreme risk classification and modifying the high risk classification;
- Clarifying when a Document of Resolution (DOR) to address IRR is warranted, including removing any presumed need for a DOR based on an IRR supervisory risk classification and related need for a credit union to develop a de-risking plan;
- Providing examiners more flexibility in assigning IRR supervisory risk ratings; and
- Revising examination procedures to incorporate updated review steps when assessing how a credit union’s management of IRR is adapting to changes in the economic and interest rate environment.
Exam staff should refer to the Examiner’s Guide for more information on examining and supervising IRR. If there is a conflict between the National Supervision Policy Manual (NSPM), the Examiner’s Guide, and this letter, exam staff must rely on this letter until the NSPM, and Examiner’s Guide are updated.3 This letter is intended to supplement existing resources on the supervision of IRR; it does not replace or supersede applicable laws and regulation.
Exam staff must remember that IRR is a major area of risk and, under certain market conditions, may expose credit unions to other related issues, such as liquidity risk, asset quality deterioration, unexpected losses to earnings, capital erosion, and strategic risk. The credit union system has experienced significant growth in complexity over the past two years with total assets growing by approximately 25 percent. As the system has grown, concentrations in longer maturity assets have significantly increased sensitivity to changes in interest rates.4
If you have any questions regarding the changes detailed in this letter, please direct them to your immediate supervisor.
I. Background
Review of a credit union’s IRR exposure has been a long-standing supervisory priority and part of the NCUA’s supervision program. Over the past decade, the NCUA has enhanced examination tools and issued periodic updates related to IRR for both staff and credit unions.
In 2012, the NCUA updated section 741.3(b) of the NCUA regulations to require credit unions with assets greater than $50 million to maintain a written policy and an effective IRR management program as part of asset liability management.5 The regulation includes Appendix A, which provides guidance for an IRR policy and an effective program.
The NCUA finalized derivatives rules providing more flexibility for federal credit unions to manage IRR in 2014 and revised the rules in 2021.6 The 2021 rule modernized the use of derivatives with a principles-based approach while retaining key safety and soundness components.
