Pub. 2 2014 Issue 2

www.uba.org 20 ant. There is a consensus among regulators that the essential risk for banks stems from long-term (or high duration) assets funded by non-maturity deposits that have surged into bank balance sheets in the wake of the Great Recession. The influx of “surge deposits” has regulators concerned about the potential for fast rising interest expense from rate sensitive liabilities. At the same time, asset values could come under great- er pressure than in past rate cycles because effective durations are relatively high. The price risk of some investment portfolios has increased significantly in the past few years due to lengthened maturities, options risk, and declining yields. Management Tools The regulatory concerns should cause bank mangers to ponder several questions The Banking Environment A s we move into a new year, the US economy continues to plod along at a slow and steady pace. Things are getting better, but we’re still far from where we were before the “Great Recession” began. Meanwhile, the banking land- scape has improved markedly as earnings clocked sixteen consecutive quarters of year-over-year increase. Returns on assets remain below pre-recession levels, but they’re higher than a year ago and comfortably above one percent. Much of the improved performance comes from healthier asset quality. Loan losses have declined to levels not seen since 2007, and provisions have fallen nearly forty percent. All of this is good news, but make no mis- take; banks face a multitude of challenges ahead. Spotlight on Interest Rate Risk Not the least of these challenges is that of potential interest rate risk (IRR). Regulatory agencies have once again ele- vated IRR as a focal point for examiners, as evidence suggests that many financial institutions are taking on higher levels of interest rate risk. Balance sheets have changed noticeably in recent years as loan demand has been weak and short- term rates have hugged historic lows. This could leave them significantly ex- posed to a sustained increase in interest rates. In October, the FDIC released an FIL on Sensitivity to Market Risk. Simultaneously, the OCC conducted a webinar to address the IRR issues they thought most import- A Priority for 2014 Interest Rate Risk: