33166 Federal Register / Vol. 61, No. 124 / Wednesday, June 26, 1996 / Notices

Acquisition Policies Act (Uniform Act)

on Federal-aid highway projects in two

of its districts through use of a

certification procedure permitted by the

Uniform Act (42 U.S.C. 4601 et seq.).

The FDOT proposed to comply with the

Uniform Act by conducting its right-ofway program in accordance with State

laws determined by the FHWA, the

Federal lead agency for the Uniform

Act, to have the same purpose and effect

as the Uniform Act. On January 24,

1996, the FHWA published a notice (61

FR 1984) informing the public that it

had accepted FDOT’s certification.

The Uniform Act provides relocation

benefits to persons forced to move by

Federal or federally-assisted programs

or projects. It also establishes policies

relating to the acquisition of real

property for such programs or projects.

The FHWA has been designated the

Federal Government’s lead agency for

implementing the Uniform Act.

Sections 210 and 305 of the Uniform

Act (42 U.S.C. 4630 and 4655) require

State agencies that receive Federal

financial assistance for programs or

projects that will result in the

acquisition of real property, or the

displacement of persons, to provide

assurances that they will comply with

the Act’s provisions. Section 103 of the

Uniform Act (42 U.S.C. 4604) provides

that, in lieu of those assurances, a State

agency may comply by certifying (and

receiving the FHWA’s determination)

that it will be operating under State

laws that ‘‘will accomplish the purpose

and effect’’ of the Uniform Act.

The FDOT applied for a certification

pilot program that would cover Uniform

Act compliance on Federal-aid highway

projects for a period of two years. The

FDOT proposed to limit the pilot

program to its Districts 2 and 4. On

September 29, 1995, after providing an

opportunity for comments, the FHWA

determined that the laws and operating

procedures relied on by the FDOT have

the same purpose and effect as the

Uniform Act and accepted FDOT’s

certification effective October 1, 1995,

for a period of two years (61 FR 1984).

The FDOT now has accumulated

sufficient experience operating under

the certification that it wishes to extend

the program to all of its districts.

In its new certification application the

FDOT relies on the same authority as its

earlier application, sections 120.543 and

339.05 of the Florida statutes and the

existing FDOT right-of-way procedures.

The two statutory provisions grant the

FDOT broad authority to comply with

Federal (Uniform Act) requirements.

The FDOT right-of-way procedures are

the mechanism for insuring the FDOT’s

compliance with the provisions of the

Uniform Act. As with the existing

certification, it is anticipated that the

level of benefits and assistance provided

to affected property owners and

displaced persons will remain virtually

unchanged since the FDOT will

continue to operate under the same laws

and procedures that it currently utilizes

in implementing the Uniform Act. The

primary changes are expected to be the

elimination of FHWA approvals or

oversight of Uniform Act

implementation in the six FDOT

districts not now covered and the

simplified administration associated

with the State operating under its own

procedures. If approved the extended

certification would run until the close of

the earlier certification, that is,

September 30, 1997.

As noted previously, under the

certification pilot program, the FHWA,

under section 103(c) of the Uniform Act,

still can withhold project approvals or

rescind acceptance of the FDOT’s

certification if the FDOT fails to comply

with the certification or with the State

law upon which the certification was

based. The FHWA and FDOT will

review the operations of the pilot

program at its midpoint and following

completion.

Authority: 42 U.S.C. 4604; 23 U.S.C. 315;

49 CFR 1.48.

Issued on: June 11, 1996.

Rodney E. Slater,

Federal Highway Administrator.

[FR Doc. 96–16261 Filed 6–25–96; 8:45 am]

BILLING CODE 4910–22–P

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the

Currency

[Docket No. 96–13]

FEDERAL RESERVE SYSTEM

[Docket No. R–0802]

FEDERAL DEPOSIT INSURANCE

CORPORATION

Joint Agency Policy Statement:

Interest Rate Risk

AGENCIES: Office of the Comptroller of

the Currency (OCC), Treasury; Board of

Governors of the Federal Reserve

System (Board); and Federal Deposit

Insurance Corporation (FDIC).

ACTION: Joint policy statement.

SUMMARY: The OCC, the Board, and the

FDIC (collectively referred to as the

agencies) are issuing this joint agency

policy statement (policy statement) to

bankers to provide guidance on sound

practices for managing interest rate risk.

The policy statement identifies the key

elements of sound interest rate risk

management and describes prudent

principles and practices for each of

these elements. It emphasizes the

importance of adequate oversight by a

bank’s board of directors and senior

management and of a comprehensive

risk management process. The policy

statement also describes the critical

factors affecting the agencies’ evaluation

of a bank’s interest rate risk when

making a determination of capital

adequacy. The principles for sound

interest rate risk management outlined

in this policy statement apply to all

commercial banks and FDIC-supervised

savings banks (banks).

This policy statement augments the

action taken by the agencies in August

1995 to implement the portion of

section 305 of the Federal Deposit

Insurance Corporation Improvement Act

of 1991 (FDICIA) addressing risk-based

capital standards for interest rate risk. It

also replaces the proposed policy

statement that the agencies issued for

comment in August 1995 regarding a

supervisory framework for measuring

and assessing banks’ interest rate

exposures. The agencies have elected

not to pursue a standardized measure

and explicit capital charge for interest

rate risk at this time. This decision

reflects concerns about the burden,

accuracy, and complexity of a

standardized measure and recognition

that industry techniques for measuring

interest rate risk are continuing to

evolve. Rather than dampening

incentives to improve risk measures by

adopting a standardized measure at this

time, the agencies hope to encourage

these industry efforts. Nonetheless, the

agencies will continue to place

significant emphasis on the level of a

bank’s interest rate risk exposure and

the quality of its risk management

process when evaluating a bank’s

capital adequacy. The principles and

practices identified in this policy

statement provide the standards upon

which the agencies will evaluate the

adequacy and effectiveness of a bank’s

interest rate risk management.

EFFECTIVE DATE: June 26, 1996.

FOR FURTHER INFORMATION CONTACT:

OCC: Christina Benson, Capital

Markets Specialist, or, Margot

Schwadron, Financial Analyst, (202/

874–5070), Office of the Chief National

Bank Examiner; Michael Carhill, Deputy

Director, Risk Analysis Division (202/

874–5700); and Ronald Shimabukuro,

Senior Attorney, Legislative and

Regulatory Activities Division (202/

874–5090), Office of the Comptroller of
Federal Register / Vol. 61, No. 124 / Wednesday, June 26, 1996 / Notices 33167

the Currency, 250 E Street, S.W.,

Washington, D.C. 20219.

Board of Governors: James Embersit,

Manager (202/452–5249), or William

Treacy, Supervisory Financial Analyst

(202/452–3859), Division of Banking

Supervision and Regulation; Gregory

Baer, Managing Senior Counsel (202/

452–3236), Legal Division, Board of

Governors of the Federal Reserve

System. For the hearing impaired only,

Telecommunication Device for the Deaf

(TDD), Dorothea Thompson (202/452–

3544), Board of Governors of the Federal

Reserve System, 20th and C Streets,

N.W., Washington, D.C. 20551.

FDIC: William A. Stark, Assistant

Director (202/898–6972) or Miguel

Browne, Deputy Assistant Director (202/

898–6789), Division of Supervision;

Jamey Basham, Counsel, (202/898-

7265), Legal Division, Federal Deposit

Insurance Corporation, 550 17th Street,

N.W., Washington, D.C. 20429.

SUPPLEMENTARY INFORMATION:

I. Background

Interest rate risk is the exposure of a

bank’s current and future earnings and

capital arising from adverse movements

in interest rates. Changes in interest

rates affect a bank’s earnings by

changing its net interest income and the

level of other interest-sensitive income

and operating expenses. Changes in

interest rates also affect the underlying

economic value of the bank’s assets,

liabilities, and off-balance sheet items.

These changes occur because the

present value of future cash flows, and

in many cases the cash flows

themselves, change when interest rates

change. The combined effects of the

changes in these present values reflect

the change in the bank’s underlying

economic value as well as provide an

indicator of the expected change in the

bank’s future earnings arising from the

change in interest rates. While interest

rate risk is inherent in the role of banks

as financial intermediaries, a bank that

has a high level of risk can face

diminished earnings, impaired liquidity

and capital positions, and, ultimately,

greater risk of insolvency.

II. FDICIA Requirements and Agencies’

Response

Section 305 of FDICIA, Pub. L. 102–

242, 105 Stat. 2236, 2354 (12 U.S.C.

1828 note), requires the agencies to

revise their risk-based capital guidelines

to take adequate account of interest rate

risk. On August 2, 1995 the agencies

published a final rule implementing

section 305 that amended their riskbased capital standards to specify that

the agencies will include, in their

evaluations of a bank’s capital

adequacy, an assessment of the

exposure to declines in the economic

value of the bank’s capital due to

changes in interest rate risk. See 60 FR

39490 (August 2, 1995). This final rule,

which became effective on September 1,

1995, adopts a ‘‘risk assessment’’

approach under which capital for

interest rate risk is evaluated on a caseby-case basis, considering both

quantitative and qualitative factors.

The final rule did not adopt a

measurement framework for assessing

the level of a bank’s interest rate risk

exposure, nor did it specify a formula

for determining the amount of capital

that would be required. The intent of

the agencies at that time was to

implement an explicit minimum capital

charge for interest rate risk at a future

date, after the agencies and the industry

had gained more experience with a

proposed supervisory measure that the

agencies issued for comment in August

1995. See 60 FR 39495 (August 2, 1995).

The agencies have undertaken

considerable efforts to develop a

supervisory measure for interest rate

risk that provides sufficient accuracy,

transparency, and predictability for

establishing an explicit charge for

interest rate risk. These efforts, and the

comments the agencies received on

them, are summarized in sections III

and IV that follow. After careful

consideration of those comments and

additional analyses and research by

agencies’ staff, the agencies have

decided that concerns about the

burdens, costs, and potential incentives

of implementing a standardized

measure and explicit capital treatment

currently outweigh the potential

benefits that such measures would

provide. The agencies are cognizant that

techniques for measuring interest rate

risk are continuing to evolve, and they

do not want to impede that progress by

mandating or implementing prescribed

risk measurement techniques. Rather,

the agencies wish to work with the

industry to encourage efforts to improve

risk measurement techniques. These

efforts, the agencies believe, may lead to

greater convergence within the industry

on the methodologies used for

measuring this risk and may, at a future

date, facilitate more quantitative and

explicit capital treatments for interest

rate risk.

Hence, the agencies have concluded

that the best course of action at this

time, is to continue to assess capital

adequacy for interest rate risk under a

risk assessment approach and to provide

the industry with further guidance on

prudent interest rate risk management

practices. Section V of this preamble

describes the agencies’ risk assessment

approach for capital. The policy

statement, which follows section V,

provides the agencies’ guidance and

expectations on sound interest rate risk

management.

III. Earlier Proposals for Supervisory

Model and Explicit Capital Charges

Since the enactment of FDICIA, the

agencies have issued two notices of

proposed rulemakings on interest rate

risk, as well as one advance notice of

proposed rulemaking (ANPR).

The ANPR was issued in 1992 and

sought comment on a proposed

supervisory measurement system and an

explicit capital requirement based on

the results of that measurement system.

See 57 FR 35507 (August 10, 1992). The

measurement system proposed in the

1992 ANPR would have applied to all

banks and used a duration-weighted

maturity ladder to estimate the change

in a bank’s economic value for an

assumed 100 basis point parallel shift in

market interest rates. Under the 1992

ANPR, a bank whose measured

exposure exceeded a threshold level,

equivalent to 1 percent of total assets,

would have been required to allocate

capital sufficient to compensate for the

estimated change in economic value

above the threshold level.

The agencies received approximately

180 comment letters on the 1992 ANPR.

The majority of commenters raised

concerns about the accuracy of the

proposed measure and its use as a basis

for an explicit capital charge. Therefore,

in September 1993, the agencies

published a notice of proposed

rulemaking which incorporated

numerous changes to the 1992 ANPR in

an effort to address those concerns and

improve the proposed model’s accuracy.

See 58 FR 48206 (September 14, 1993).

These changes included:

(1) A proposed screen that would

exempt banks identified as potentially

low-risk from the supervisory

measurement framework.

(2) Various refinements to the

supervisory model, including changes to

the method for determining risk weights

to allow for different risk weights for

rising and falling interest rate

environments; the specific treatment of

non-maturity deposits; the reporting of

amortizing and non-amortizing financial

instruments; and the addition of another

time band to provide for greater

accuracy.

The September 1993 proposal also

sought comment on allowing banks to

use their own internal models as the

basis for establishing a capital charge

and on two different methods for

assessing capital. One method, referred
33168 Federal Register / Vol. 61, No. 124 / Wednesday, June 26, 1996 / Notices

to as the minimum capital standard,

would establish an explicit capital

charge for interest rate risk based on

either the supervisory model or a bank’s

internal model results. The other

method, referred to as the risk

assessment approach, would evaluate

the need for capital on a case-by-case

basis, considering both quantitative and

qualitative factors.

The agencies collectively received a

total of 133 comments on the September

1993 proposal. The majority of industry

comments focused on four issues: a

preference for the risk assessment

approach, approval of the proposed use

of internal models, concerns about the

accuracy of the proposed supervisory

model, and suggestions that the

agencies’ primary focus should be on

near-term (i.e., one- to two-year)

reported earnings instead of economic

value.

In August 1995, along with the final

rule amending risk-based capital

standards to adopt the risk assessment

approach, the agencies issued for

comment a joint policy statement that

would establish a supervisory

framework for measuring banks’ interest

rate risk exposures. See 60 FR 39495

(August 2, 1995). The results of that

framework would be one factor that

examiners would consider in evaluating

a bank’s capital adequacy for interest

rate risk. In addition, the agencies noted

that the framework was intended to

provide the foundation for the

development of an explicit capital

charge once the agencies and industry

gained more experience with the

measurement framework.

The August 1995 proposal built upon

and modified the agencies’ earlier

proposals for a supervisory

measurement framework in an effort to

improve the framework’s accuracy and

applicability to a diverse population of

banks. Modifications included:

(1) Changing the proposed exemption

test so that only banks with total assets

less than $300 million, a ‘‘1’’ or ‘‘2’’

composite supervisory CAMEL rating,

and only moderate holdings of assets

with intermediate or long term repricing

characteristics would be exempted from

new interest rate risk reporting

requirements and the supervisory

model.

(2) Refinements to a baseline

supervisory model for which all nonexempt banks would provide

Consolidated Reports of Condition and

Income (Call Report) information. These

refinements included separate reporting

and treatment of fixed- and adjustablerate residential mortgage loans and

securities and other amortizing assets;

requiring banks holding certain types of

financial instruments to report estimates

of changes in the market value

sensitivities of those instruments for a

200 basis point interest rate shock; and,

extending the range of maturities that

banks could use when reporting their

non-maturity deposits (demand

deposits, savings, NOW, and money

market demand accounts).

(3) The introduction of supplemental

modules for non-exempted banks that

had concentrations in fixed- or

adjustable-rate residential mortgage

loans and pass-through securities. Banks

subject to these modules would report

additional information on the coupon

distributions of their fixed-rate

mortgages and information on the

lifetime and periodic caps of their

adjustable-rate mortgages.

Although these modifications were

designed to enhance and improve upon

the agencies’ earlier proposals, the

majority of commenters on the August

1995 proposal reiterated many previous

concerns about accuracy, burden, and

incentives, and urged the agencies to

reconsider their approach and efforts to

devise a uniform and standardized

model.

IV. Factors Leading to the Agencies’

Decision to Not Pursue a Supervisory

Model

As already noted, the agencies have

decided not to pursue a standardized

model for supervisory purposes or

assessing capital charges for interest rate

risk at this time. This decision reflects

the continued concerns expressed by

the industry in their comment letters on

the August 1995 proposal and the

numerous difficulties the agencies

encountered in trying to develop and

implement a standardized measure that

had sufficient accuracy and flexibility to

be applicable to a broad range of

commercial banks, while not imposing

undue regulatory and reporting burdens

on banks.

Throughout the evolution of the

agencies’ efforts to incorporate an

explicit capital charge for interest rate

risk into their risk-based capital

standards, industry comments have

expressed four fundamental concerns:

(1) An approach whose sole focus is

on economic value, rather than on

reported earnings, may be

inappropriate;

(2) A supervisory measure that by

necessity, makes uniform and

simplifying assumptions about the

characteristics of a typical bank’s assets

and liabilities may be inaccurate for a

given institution;

(3) The proposed treatment for nonmaturity deposits may be inappropriate

in many cases; and

(4) Any supervisory model may create

improper incentives for internal risk

management and measurement. Each of

these concerns is addressed in turn.

The agencies continue to believe

economic value sensitivity is a valid

and important concept, especially when

assessing an institution’s capital

adequacy and, as noted, have amended

their capital standards to reflect this

view. Nonetheless, the agencies

recognize that changes in a bank’s

reported earnings is also important and

that a bank needs to consider both

earnings and economic perspectives

when assessing the full scope of its

exposure. This policy statement adopted

by the agencies sets forth principles for

monitoring and controlling interest rate

risk from both of these perspectives.

The industry’s concerns about the

validity and accuracy of a standardized

model present a more difficult and

serious issue. Some of the changes in

the August 1995 proposal attempted to

address these concerns. For example,

supplemental schedules for residential

mortgage loans and pass-through

securities were a response to earlier

industry concerns regarding the use of

prepayment assumptions that were

based on an average of outstanding

mortgage securities. By collecting

additional data on the embedded

options in an individual bank’s

mortgage portfolio, the accuracy of the

proposed model was potentially

enhanced. However, the changes were

not without cost. In particular, the

supplemental schedules and associated

risk weights added to the reporting

burden and overall complexity of the

proposal. By giving the appearance of

providing a more precise measure of

risk, they also increased the likelihood

that the standardized measure would

replace or stifle development of yet

more accurate internal measures of risk

exposure. This added reporting burden

and complexity illustrates the

difficulties the agencies have faced in

trying to strike an appropriate balance

between accuracy and burden.

Not only did the mortgage schedules

add burden, they did not fundamentally

solve the difficulties of structuring a

standardized model which could take

into account the heterogenous nature of

commercial banks’ balance sheet

structures and activities. In recent years,

banks have been offering and holding a

growing variety of products. Many of

these products, such as certain

collateralized mortgage obligations and

structured notes, can have complex cash

flow characteristics that vary

significantly with each transaction. The

August 1995 proposal attempted to

address this problem by requiring banks
Federal Register / Vol. 61, No. 124 / Wednesday, June 26, 1996 / Notices 33169

1The focus of this Statement is on the interest

rate risk found in banks’ non-trading activities.

Each agency has separate guidance regarding the

prudent risk management of trading activities.

to self-report the sensitivity of these and

certain other instruments. The diversity

and complexity in banks’ holdings,

however, are not limited to a bank’s

investment and off-balance sheet

instruments. Increasingly, banks have a

variety of pricing indices and embedded

options incorporated into their

commercial and retail bank products,

making it increasingly difficult to model

these products with any simple and

uniform measure.

The diversity and complexity of

commercial banks’ balance sheets is one

reason why the banking agencies have

decided not to pursue adopting the net

portfolio value model developed and

used by the Office of Thrift Supervision

(OTS) or any uniform supervisory

model. Although the banking agencies

have benefited a great deal from the

expertise and experience of the OTS in

this area, the OTS model was designed

to ascertain the interest rate risk

exposure of insured depository

institutions with concentrations of

residential mortgage assets, especially

adjustable rate mortgages. These

instruments require data-intensive,

complex models to obtain accurate

valuations and interest rate sensitivities.

Since most commercial banks do not

hold high concentrations of these

instruments, the agencies were

concerned about the substantial

reporting requirements and

measurement complexity that would be

associated with an OTS type of model

if applied to commercial banks.

Many industry commenters believe

that the agencies’ treatment in the

August 1995 proposal of non-maturity

deposits understated their effective

maturity and urged the agencies to

allow banks greater flexibility in the

reporting and treatment of them.

Assumptions about the effective

maturity of these deposits are critical

factors in assessing most commercial

banks’ interest rate risk exposure, since

these deposits often represent 40

percent or more of a bank’s liability

base. Thus, while the agencies have

elected not to adopt supervisory

assumptions for calculating the effective

maturities of non-maturity deposits, the

policy statement cautions banks to make

reasonable assumptions about customer

behavior in this area, and periodically

re-evaluate whether the assumptions are

reasonable in light of experience.

The supervisory treatment of nonmaturity deposits in measuring interest

rate risk also illustrates the industry’s

concern regarding the potential

incentives a supervisory model could

present to a bank. In particular, some

industry commenters have stated that if

the agencies adopted assumptions that

understated the effective maturities of a

bank’s non-maturity deposits, it could

induce a bank to inappropriately

shorten its asset maturities, leave the

bank exposed to falling interest rates,

and unnecessarily reduce its net interest

margins. The agencies, however, are

also concerned that an assumption that

overstated the maturity of these deposits

could mistakenly lead banks to extend

their asset maturities, leaving them

exposed to rising interest rates and

significant loss in economic value.

Many commenters voiced broader

concerns about the potential incentives

that a standardized supervisory model

may have on how banks manage and

measure their risk. A frequent concern

has been that a supervisory model

would become the industry standard

against which internal models would be

benchmarked and tested, thus diverting

resources away from improving internal

models and assumptions.

The agencies neither wish to create

inappropriate incentives, nor divert

industry resources from the

development of better interest rate risk

measurements. The policy statement

consequently emphasizes each

institution’s responsibility to develop

and refine interest rate risk management

practices that are appropriate and

effective for its specific circumstances.

V. Risk Assessment Approach

The risk assessment approach that the

agencies use to evaluate a bank’s capital

adequacy for interest rate risk relies on

a combination of quantitative and

qualitative factors. The agencies will use

various quantitative screens and filters

as tools to identify banks that may have

high exposures or complex risk profiles,

to allocate examiner resources, and to

set examination priorities. These tools

rely on Call Report data and various

economic indicators and data. To make

assessments about the level of a bank’s

interest rate exposure, examiners

augment the insights provided by these

preliminary indicators with the

quantitative exposure estimates

generated by a bank’s internal risk

measurement systems. For most banks

the results of their internal risk

measures are and will continue to be the

primary factor that examiners consider

when assessing a bank’s level of

exposure.

On the qualitative side, examiners

will continue to evaluate whether a

bank follows sound risk management

practices for interest rate risk when

assessing its aggregate interest rate risk

exposure and its need for capital. Such

practices include, but are not limited to,

adequate risk measurement systems.

Indeed, as the agencies explored various

approaches for developing supervisory

risk measures, it reinforced their

appreciation for the critical roles that

management and board oversight, risk

controls, and prudent judgment and

experience play in the interest rate risk

management process.

Banks that are found to have high

levels of exposure and/or weak

management practices will be directed

by the agencies to take corrective action.

Such actions will include directives to

raise additional capital, strengthen

management expertise, improve

management information and

measurement systems, reduce levels of

exposure, or a combination thereof.

Joint Agency Policy Statement on

Interest Rate Risk

Purpose

This joint agency policy statement

(‘‘Statement’’) provides guidance to

banks on prudent interest rate risk

management principles. The three

federal banking agencies—the Board of

Governors of the Federal Reserve

System, the Federal Deposit Insurance

Corporation, and the Office of the

Comptroller of the Currency

(‘‘agencies’’)—believe that effective

interest rate risk management is an

essential component of safe and sound

banking practices. The agencies are

issuing this Statement to provide

guidance to banks on this subject and to

assist bankers and examiners in

evaluating the adequacy of a bank’s

management of interest rate risk.1

This Statement applies to all

federally-insured commercial and FDIC

supervised savings banks [’’banks’’].

Because market conditions, bank

structures, and bank activities vary,

each bank needs to develop its own

interest rate risk management program

tailored to its needs and circumstances.

Nonetheless, there are certain elements

that are fundamental to sound interest

rate risk management, including

appropriate board and senior

management oversight and a

comprehensive risk management

process that effectively identifies,

measures, monitors and controls risk.

This Statement describes prudent

principles and practices for each of

these elements.

The adequacy and effectiveness of a

bank’s interest rate risk management

process and the level of its interest rate

exposure are critical factors in the

agencies’ evaluation of the bank’s

capital adequacy. A bank with material
33170 Federal Register / Vol. 61, No. 124 / Wednesday, June 26, 1996 / Notices

2The economic value of an instrument represents

an assessment of the present value of the expected

net future cash flows of the instrument, discounted

to reflect market rates. A bank’s economic value of

equity (EVE) represents the present value of the

expected cash flows on assets minus the present

value of the expected cash flows on liabilities, plus

or minus the present value of the expected cash

flows on off-balance sheet instruments.

weaknesses in its risk management

process or high levels of exposure

relative to its capital will be directed by

the agencies to take corrective action.

Such actions will include

recommendations or directives to raise

additional capital, strengthen

management expertise, improve

management information and

measurement systems, reduce levels of

exposure, or some combination thereof,

depending upon the facts and

circumstances of the individual

institution.

When evaluating the applicability of

specific guidelines provided in this

Statement and the level of capital

needed for interest rate risk, bank

management and examiners should

consider factors such as the size of the

bank, the nature and complexity of its

activities, and the adequacy of its

capital and earnings in relation to the

bank’s overall risk profile.

Background

Interest rate risk is the exposure of a

bank’s financial condition to adverse

movements in interest rates. It results

from differences in the maturity or

timing of coupon adjustments of bank

assets, liabilities and off-balance-sheet

instruments (repricing or maturitymismatch risk); from changes in the

slope of the yield curve (yield curve

risk); from imperfect correlations in the

adjustment of rates earned and paid on

different instruments with otherwise

similar repricing characteristics (basis

risk—e.g. 3 month Treasury bill versus

3 month LIBOR); and from interest raterelated options embedded in bank

products (option risk).

Changes in interest rates affect a

bank’s earnings by changing its net

interest income and the level of other

interest-sensitive income and operating

expenses. Changes in interest rates also

affect the underlying economic value 2

of the bank’s assets, liabilities and offbalance sheet instruments because the

present value of future cash flows and

in some cases, the cash flows

themselves, change when interest rates

change. The combined effects of the

changes in these present values reflect

the change in the bank’s underlying

economic value.

As financial intermediaries banks

accept and manage interest rate risk as

an inherent part of their business.

Although banks have always had to

manage interest rate risk, changes in the

competitive environment in which

banks operate and in the products and

services they offer have increased the

importance of prudently managing this

risk. This guidance is intended to

highlight the key elements of prudent

interest rate risk management. The

agencies expect that in implementing

this guidance, bank boards of directors

and senior managements will provide

effective oversight and ensure that risks

are adequately identified, measured,

monitored and controlled.

Board and Senior Management

Oversight

Effective board and senior

management oversight of a bank’s

interest rate risk activities is the

cornerstone of a sound risk management

process. The board and senior

management are responsible for

understanding the nature and level of

interest rate risk being taken by the bank

and how that risk fits within the overall

business strategies of the bank. They are

also responsible for ensuring that the

formality and sophistication of the risk

management process is appropriate for

the overall level of risk. Effective risk

management requires an informed

board, capable management and

appropriate staffing.

For its part, a bank’s board of

directors has two broad responsibilities:

• To establish and guide the bank’s

tolerance for interest rate risk, including

approving relevant risk limits and other

key policies, identifying lines of

authority and responsibility for

managing risk, and ensuring adequate

resources are devoted to interest rate

risk management.

• To monitor the bank’s overall

interest rate risk profile and ensure that

the level of interest rate risk is

maintained at prudent levels.

Senior management is responsible for

ensuring that interest rate risk is

managed on both a long range and dayto-day basis. In managing the bank’s

activities, senior management should:

• Develop and implement policies

and procedures that translate the

board’s goals, objectives, and risk limits

into operating standards that are well

understood by bank personnel and that

are consistent with the board’s intent.

• Ensure adherence to the lines of

authority and responsibility that the

board has approved for measuring,

managing, and reporting interest rate

risk exposures.

• Oversee the implementation and

maintenance of management

information and other systems that

identify, measure, monitor, and control

the bank’s interest rate risk.

• Establish internal controls over the

interest rate risk management process.

Risk Management Process

Effective control of interest rate risk

requires a comprehensive risk

management process that includes the

following elements:

• Policies and procedures designed to

control the nature and amount of

interest rate risk the bank takes

including those that specify risk limits

and define lines of responsibilities and

authority for managing risk.

• A system for identifying and

measuring interest rate risk.

• A system for monitoring and

reporting risk exposures.

• A system of internal controls,

review and audit to ensure the integrity

of the overall risk management process.

The formality and sophistication of

these elements may vary significantly

among institutions, depending upon the

level of the bank’s risk and the

complexity of its holdings and

activities. Banks with non-complex

activities and relatively short-term

balance sheet structures presenting

relatively low risk levels and whose

senior managers are actively involved in

the details of day-to-day operations may

be able to rely on a relatively basic and

less formal interest rate risk

management process, provided their

procedures for managing and

controlling risks are communicated

clearly and are well understood by all

relevant parties.

More complex organizations and

those with higher interest rate risk

exposures or holdings of complex

instruments with significant interest

rate-related option characteristics may

require more elaborate and formal

interest rate risk management processes.

Risk management processes for these

banks should address the institution’s

broader and typically more complex

range of financial activities and provide

senior managers with the information

they need to monitor and direct day-today activities. Moreover, the more

complex interest rate risk management

processes employed at these institutions

require adequate internal controls that

include internal and/or external audits

or other appropriate oversight

mechanisms to ensure the integrity of

the information used by the board and

senior management in overseeing

compliance with policies and limits.

Those individuals involved in the risk

management process (or risk

management units) in these banks must

be sufficiently independent of the

business lines to ensure adequate
Federal Register / Vol. 61, No. 124 / Wednesday, June 26, 1996 / Notices 33171

separation of duties and to avoid

conflicts of interest.

Risk Controls and Limits

The board and senior management

should ensure that the structure of the

bank’s business and the level of interest

rate risk it assumes are effectively

managed and that appropriate policies

and practices are established to control

and limit risks. This includes

delineating clear lines of responsibility

and authority for the following areas:

• Identifying the potential interest

rate risk arising from existing or new

products or activities;

• Establishing and maintaining an

interest rate risk measurement system;

• Formulating and executing

strategies to manage interest rate risk

exposures; and,

• Authorizing policy exceptions.

In some institutions the board and

senior management may rely on a

committee of senior managers to manage

this process. An institution should also

have policies for identifying the types of

instruments and activities that the bank

may use to manage its interest rate risk

exposure. Such policies should clearly

identify permissible instruments, either

specifically or by their characteristics,

and should also describe the purposes

or objectives for which they may be

used. As appropriate to the size and

complexity of the bank, the policies

should also help delineate procedures

for acquiring specific instruments,

managing portfolios, and controlling the

bank’s aggregate interest rate risk

exposure.

Policies that establish appropriate risk

limits that reflect the board’s risk

tolerance are an important part of an

institution’s risk management process

and control structure. At a minimum

these limits should be board approved

and ensure that the institution’s interest

rate exposure will not lead to an unsafe

and unsound condition. Senior

management should maintain a bank’s

exposure within the board-approved

limits. Limit controls should ensure that

positions that exceed certain

predetermined levels receive prompt

management attention. An appropriate

limit system should permit management

to control interest rate risk exposures,

initiate discussion about opportunities

and risk, and monitor actual risk taking

against predetermined risk tolerances.

A bank’s limits should be consistent

with the bank’s overall approach to

measuring interest rate risk and should

be based on capital levels, earnings,

performance, and the risk tolerance of

the institution. The limits should be

appropriate to the size, complexity and

capital adequacy of the institution and

address the potential impact of changes

in market interest rates on both reported

earnings and the bank’s economic value

of equity (EVE). From an earnings

perspective a bank should explore limits

on net income as well as net interest

income in order to fully assess the

contribution of non-interest income to

the interest rate risk exposure of the

bank. Such limits usually specify

acceptable levels of earnings volatility

under specified interest rate scenarios.

A bank’s EVE limits should reflect the

size and complexity of its underlying

positions. For banks with few holdings

of complex instruments and low risk

profiles, simple limits on permissible

holdings or allowable repricing

mismatches in intermediate- and longterm instruments may be adequate. At

more complex institutions, more

extensive limit structures may be

necessary. Banks that have significant

intermediate- and long-term mismatches

or complex options positions should

have limits in place that quantify and

constrain the potential changes in

economic value or capital of the bank

that could arise from those positions.

Identification and Measurement

Accurate and timely identification

and measurement of interest rate risk

are necessary for proper risk

management and control. The type of

measurement system that a bank

requires to operate prudently depends

upon the nature and mix of its business

lines and the interest rate risk

characteristics of its activities. The

bank’s measurement system(s) should

enable management to recognize and

identify risks arising from the bank’s

existing activities and from new

business initiatives. It should also

facilitate accurate and timely

measurement of its current and

potential interest rate risk exposure.

The agencies believe that a wellmanaged bank will consider both

earnings and economic perspectives

when assessing the full scope of its

interest rate risk exposure. The impact

on earnings is important because

reduced earnings or outright losses can

adversely affect a bank’s liquidity and

capital adequacy. Evaluating the

possibility of an adverse change in a

bank’s economic value of equity is also

useful, since it can signal future

earnings and capital problems. Changes

in economic value can also affect the

liquidity of bank assets, because the cost

of selling depreciated assets to meet

liquidity needs may be prohibitive.

Since the value of instruments with

intermediate and long maturities or

embedded options is especially

sensitive to interest rate changes, banks

with significant holdings of these

instruments should be able to assess the

potential longer-term impact of changes

in interest rates on the value of these

positions and the future performance of

the bank.

Measurement systems for evaluating

the effect of rates on earnings may focus

on either net interest income or net

income. Institutions with significant

non-interest income that is sensitive to

changing rates should focus special

attention on net income. Measurement

systems used to assess the effect of

changes in interest rates on reported

earnings range from simple maturity gap

reports to more sophisticated income

simulation models. Measurement

approaches for evaluating the potential

effect on economic value of an

institution may, depending on the size

and complexity of the institution, range

from basic position reports on holdings

of intermediate, long-term and/or

complex instruments to simple

mismatch weighting techniques to

formal static or dynamic cash flow

valuation models.

Regardless of the type and level of

complexity of the measurement system

used, bank management should ensure

the adequacy and completeness of the

system. Because the quality and

reliability of the measurement system is

largely dependent upon the quality of

the data and various assumptions used

in the model, management should give

particular attention to these items.

The measurement system should

include all material interest rate

positions of the bank and consider all

relevant repricing and maturity data.

Such information will generally include

(i) current balance and contractual rate

of interest associated with the

instruments and portfolios, (ii) principal

payments, interest reset dates,

maturities, and (iii) the rate index used

for repricing and contractual interest

rate ceilings or floors for adjustable-rate

items. The system should also have

well-documented assumptions and

techniques.

Bank management should ensure that

risk is measured over a probable range

of potential interest rate changes,

including meaningful stress situations.

In developing appropriate rate

scenarios, bank management should

consider a variety of factors such as the

shape and level of the current term

structure of interest rates and historical

rate movements. The scenarios used

should incorporate a sufficiently wide

change in market interest rates (e.g.,

+/¥ 200 basis points over a one year

horizon) and include immediate or

gradual changes in market interest rates

as well as changes in the shape of the
33172 Federal Register / Vol. 61, No. 124 / Wednesday, June 26, 1996 / Notices

yield curve in order to capture the

material effects of any explicit or

embedded options.

Assumptions about customer behavior

and new business activity should be

reasonable and consistent with each rate

scenario that is evaluated. In particular,

as part of its measurement process, bank

management should consider how the

maturity, repricing and cash flows of

instruments with embedded options

may change under various scenarios.

Such instruments would include loans

that can be prepaid without penalty

prior to maturity or have limits on the

coupon adjustments, and deposits with

unspecified maturities or rights of early

withdrawal.

Monitoring and Reporting Exposures

Institutions should also establish an

adequate system for monitoring and

reporting risk exposures. A bank’s

senior management and its board or a

board committee should receive reports

on the bank’s interest rate risk profile at

least quarterly. More frequent reporting

may be appropriate depending on the

bank’s level of risk and the potential

that the level of risk could change

significantly. These reports should

allow senior management and the board

or committee to:

• Evaluate the level and trends of the

bank’s aggregated interest rate risk

exposure.

• Evaluate the sensitivity and

reasonableness of key assumptions—

such as those dealing with changes in

the shape of the yield curve or in the

pace of anticipated loan prepayments or

deposit withdrawals.

• Verify compliance with the board’s

established risk tolerance levels and

limits and identify any policy

exceptions.

• Determine whether the bank holds

sufficient capital for the level of interest

rate risk being taken.

The reports provided to the board and

senior management should be clear,

concise, and timely and provide the

information needed for making

decisions.

Internal Control, Review, and Audit of

the Risk Management Process

A bank’s internal control structure is

critical to the safe and sound

functioning of the organization

generally, and to its interest rate risk

management process in particular.

Establishing and maintaining an

effective system of controls, including

the enforcement of official lines of

authority and the appropriate separation

of duties, are two of management’s more

important responsibilities. Individuals

responsible for evaluating risk

monitoring and control procedures

should be independent of the function

they are assigned to review.

Effective control of the interest rate

risk management process includes

independent review and, where

appropriate, internal and external audit.

The bank should conduct periodic

reviews of its risk management process

to ensure its integrity, accuracy and

reasonableness. Items that should be

reviewed and validated include:

• The adequacy of, and personnel’s

compliance with, the bank’s internal

control system.

• The appropriateness of the bank’s

risk measurement system given the

nature, scope and complexity of its

activities.

• The accuracy and completeness of

the data inputs into the bank’s risk

measurement system.

• The reasonableness and validity of

scenarios used in the risk measurement

system.

• The validity of the risk

measurement calculations. The validity

of the calculations is often tested by

comparing actual versus forecasted

results.

The scope and formality of the review

and validation will depend on the size

and complexity of the bank. At large

banks, internal and external auditors

may have their own models against

which the bank’s model is tested. Banks

with complex risk measurement systems

should have their models or

calculations validated by an

independent source—either an internal

risk control unit of the bank or by

outside auditors or consultants.

The findings of this review should be

reported to the board on an annual

basis. The report should provide a brief

summary of the bank’s interest rate risk

measurement techniques and

management practices. It also should

identify major critical assumptions used

in the risk measurement process,

discuss the process used to derive those

assumptions and provide an assessment

of the impact of those assumptions on

the bank’s measured exposure.

Dated: May 13, 1996.

Eugene A. Ludwig,

Comptroller of the Currency.

By order of the Board of Governors of the

Federal Reserve System.

Dated: May 23, 1996.

William W. Wiles,

Secretary of the Board.

By order of the Board of Directors.

Dated at Washington, DC, this 14th day of

May, 1996.

Robert E. Feldman,

Deputy Executive Secretary.

[FR Doc. 96–16300 Filed 6–25–96; 8:45 am]

BILLING CODES: 4810–33–P; 6210–01–P; 6714–01–P

Internal Revenue Service

Proposed Collection; Comment

Request for Form 8843

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Notice and request for

comments.

SUMMARY: The Department of the

Treasury, as part of its continuing effort

to reduce paperwork and respondent

burden, invites the general public and

other Federal agencies to take this

opportunity to comment on proposed

and/or continuing information

collections, as required by the

Paperwork Reduction Act of 1995,

Public Law 104–13 (44 U.S.C.

3506(c)(2)(A)).

Currently, the IRS is soliciting

comments concerning Form 8843,

Statement for Exempt Individuals and

Individuals With a Medical Condition.

DATES: Written comments should be

received on or before August 26, 1996,

to be assured of consideration.

ADDRESSES: Direct all written comments

to Garrick R. Shear, Internal Revenue

Service, room 5571, 1111 Constitution

Avenue NW., Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT:

Requests for additional information or

copies of the form(s) and instructions

should be directed to Martha R. Brinson,

(202) 622–3869, Internal Revenue

Service, room 5571, 1111 Constitution

Avenue NW., Washington, DC 20224.

SUPPLEMENTARY INFORMATION:

Title: Statement for Exempt

Individuals and Individuals With a

Medical Condition.

OMB Number: 1545–1411.

Form Number: Form 8843.

Abstract: Form 8843 is used by an

alien individual to explain the basis of

the individual’s claim that he or she is

able to exclude days of presence in the

United States because the individual is

a teacher/trainee or student;

professional athlete; or has a medical

condition or problem.

Current Actions: There are no changes

being made to this form at this time.

Type of Review: Extension of a

currently approved collection.

Affected Public: Individuals or

households.

Estimated Number of Respondents:

150,000.