Testing of the ALM Process: What Should it Really Entail?

Transcription

1 Testing of the ALM Process: What Should it Really Entail? Tuesday, June 18, :00 PM 3:15 PM Presented by: Bert Purdy, CPA, CTFA Senior Manager BKD, LLP 211 N. Broadway, Suite 600 St. Louis, MO P: E:

2 Perhaps when a man has special knowledge & special powers like my own, it rather encourages him to seek a complex explanation when a simpler one is at hand. Sherlock Holmes slide 2

3 Questions to be Answered 1. What testing of the ALM process is required? 2. What are the differences between model validation & ALM testing? 3. How can you perform model backtesting? 4. What are examiner expectations? slide 3

4 Regulatory Guidance Joint Agency Policy Statement on Interest Rate Risk (1996) Comptroller s Handbook on Interest Rate Risk (1997) Advisory on Interest Rate Risk Management (2010) Interest Rate Risk Management: Frequently Asked Questions (2012) slide 4

5 Regulatory Guidance FDIC s Risk Management Manual of Examination Policies, Section 7.1 Sensitivity to Market Risk Comptroller s Handbook, Community Bank Supervision, Sensitivity to Market Risk (pages 77-85) FRB s Commercial Bank Examination Manual, Section slide 5

6 Related Guidance FIL Liquidity Risk Management Interagency Policy Statement on Funding & Liquidity Risk Management OCC Supervisory Guidance on Model Risk Management FRB s Commercial Bank Examination Manual, Section 4027 (Model Risk Management) slide 6

7 Required Testing Internal controls, policies, procedures (Process testing) Model validation Back-testing slide 7

8 Process Testing Purpose: to ensure that the interest rate risk measurement & management processes are sound. - FDIC Exam Manual slide 8

9 Process Testing Complexity Structure slide 9

10 Process Testing Independent: Person testing should not have any involvement in either developing the measurement system or performing any of the routine internal functions such as reconciling data inputs, developing assumptions, or performing variance analysis. - FDIC Exam Manual slide 10

11 Process Testing Independence can be achieved via internal audit staff, an outsourcing arrangement or a combination of the two slide 11

12 Process Testing Four phases of process testing Input process Assumptions System output Management & oversight (ALCO) slide 12

13 Process Testing Input Process Knowledge & skills Reconciliation Numbers in right places Contractual terms Review slide 13

14 Process Testing Assumptions How are they developed? Review & approval at set-up Periodic review Supporting documentation slide 14

15 Process Testing System Output Accuracy Interest rate scenarios Ramps & shocks Timeliness & frequency of reporting Compliance with policy slide 15

16 Process Testing Management & Oversight Policy ALCO membership Frequency Policy exceptions Assumptions Vendor due diligence slide 16

17 Model Validation Institutions that use vendor-supplied models are not required to test the mechanics & mathematics of the measurement model. However, the vendor should provide documentation showing a credible independent third party has performed such a function. - Advisory on Interest Rate Risk Management slide 17

18 Model Validation Third party validation reports Frequency Review Implement changes slide 18

19 Model Validation Use of a separate model provider Use same processes for input Use same assumptions Compare results slide 19

20 Back-testing Purpose Frequency Complexity slide 20

21 Back-testing Independence Performance Results slide 21

22 Examinations Independent Review The person responsible for conducting the annual independent review is not independent of the control of the model as this person is responsible for monthly data inputs, reconciliations & assumption changes slide 22

23 Examinations Independent Review A contravention of the Joint Agency Policy Statement on Interest Rate Risk is identified as an independent review of the bank s input & assumptions has not been conducted slide 23

24 Examinations Management s analysis of the bank s exposure to interest rate risk does not include interest rate shocks of at least 300 to 400 basis points according to FDIC s Financial Institution Letter entitled Financial Institution Management of Interest Rate Risk dated January 20, 2012 slide 24

25 Examinations Only two formal Asset/Liability Committee (ALCO) meetings have been held since the last examination, although bank policy calls for quarterly meetings. Management meets informally outside of ALCO meetings to discuss IRR & maintains notes of those meetings; however, the notes are not presented to the Board for review. Further, while management stated IRR matters are discussed at the Board meetings in the absence of ALCO meetings, Board minutes lack sufficient detail of those discussions. slide 25

26 Examinations Guidelines in the Asset Liability Management Policy remain liberal, as was noted at the prior examination. Management should narrow the risk parameters which continue to allow for NII changes of 10, 15 & 201 percent for 100, 200 & 300 basis point rate shocks, respectively. slide 26

27 Examinations Though the bank s sensitivity to market risk is satisfactory, many parameters established in the policy are liberal & allow for an inordinate amount of risk. The policy should be amended to incorporate parameters that minimize risk & establish limits for the level of risk the bank is willing to accept. slide 27

28 Questions? slide 28