Financial Institutions

A Framework for Interest Rate Risk Management

Banks are often unknowingly exposed to risk due to balance sheet structure, and they often seek to change that composition through pricing and customer incentives. While this approach can be effective, it takes a long time and tends to be costly.

The key to avoiding this risk is to accurately quantify your exposure to interest rate movements.

  • Determine your strategy: Specify your risk appetite in relation to your annual objectives. What limits exist and what is their impact on your net interest income? Map the relevant policy statements to OCC-defined risk categories, and develop procedures to implement the policy statements.
  • Measure and monitor: Measure interest rate sensitivity and analyze potential hedge structures to move towards your objective.
  • Implement and execute: Recommend potential hedge structures and strategies. Simplify needless complexity, and compare the impact of alternate hedging strategies on net interest income.
  • Evaluate and assess: Address the regulatory, governance, credit accounting, and educational requirements of each recommendation and create a plan to execute.

By using these strategies, Grayline can optimize you institution’s unique objectives and constraints relative to profitability, liquidity, cash flow and income at risk, as well as operational, regulatory, and accounting considerations. A successful framework for interest rate risk management must combine leading practices with regulatory and accounting guidance, with specific attention paid to an institution’s unique risk appetite and strategic objectives.

To learn more about how Grayline can help with managing interest rate risk, contact us.

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Measuring Risk to Hedge CVAs

The market volatility experienced during the 2008 financial crisis has driven many firms to review their methods of accounting for counterparty credit risk.

The traditional approach of controlling counterparty credit risk has been to set limits against future exposures and verify potential trades against these limits. Credit Value Adjustment (CVA) offers an opportunity for banks to move beyond the control mindset of limits by dynamically pricing counterparty credit risk directly into new trades.

Many banks already measure CVA in their accounting statements, but the financial crisis has led pioneering banks to invest in systems that more accurately assess CVA, and integrate CVA into pre-deal pricing and structuring. Their expected return on investment is the ability to support future growth by freeing up more capital and minimizing earnings volatility.

But how do you quantify these risks? How, for example, do you measure reputation risk?

In Douglas W. Hubbard’s book, "How to Measure Anything," he defines risks like these and lays out helpful ways to think about quantification. Without that, trying to manage these risks is impractical at best. At worst, it’s a foolish waste of time that does no more than check a box.

Beyond the Box

Arguably, going “outside the box” may not be required in order to employ leading practices in the realm of risk management and regulatory compliance. It is almost certain, however, that managers move beyond the mentality of simply “checking the box.” That is, merely doing anything just to “get it done” will leave the company in an undesirable state. At the very least, managers and employees will be without direction; more than likely, they will go astray and incur even risk without benefit.

Using a proprietary assessment tool, Grayline helps companies evaluate and rank the state of their internal risk measurement and reporting. Contact us today for a complimentary assessment.

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