Contact: Stephanie E. Kalahurka; Spencer Fane Britt & Browne LLP (Missouri, USA)
The news is rolling in from both banks and regulators -- interest rate risk (“IRR”) will be a primary focus of upcoming safety and soundness examinations. In the current market of tight net interest margins and slow loan growth, regulators are concerned that banks may begin reaching for higher yields in the form of longer-term assets. This concern could be well-founded given the strong forces that are creating incentives on both sides of the closing table.
In the current low interest rate environment, borrowers believe that rates can only go up, and so there is a strong incentive to lock in the low rates for a longer term. To obtain the longer-term lock, borrowers are typically willing to pay a premium. On the other side of the table, lenders are feeling pressure of tight net interest margins and tough loan competition. Consequently, they also have an incentive to target longer-term, higher-yielding returns. While these incentives may temporarily alleviate the pressure of declining net interest margins, regulators are concerned that they may also expose banks to additional risks. When rates eventually increase, regulators predict that lenders will ultimately be forced to fund their new long-term assets with higher-priced liabilities.
Both state and federal regulators have recently and repeatedly emphasized that banks must have a robust process for measuring, and where necessary, mitigating their exposure to increasing interest rates. While this recommendation is certainly not new, the intensity of the recent regulatory scrutiny strongly suggests that bankers should be conducting internal reviews and updates of their IRR management function prior to the time that examiners walk in the door.
Read more at: Spencer Fane's Community Bank Counselors Blog
