It’s no secret that bank examiners are pressuring community banks to step-up their interest rate risk measurement processes. Armed with the new “requirements” (and I use that term loosely) that were outlined in the 2010 IRR Advisory, examiners are asking banks to run an ever increasing number of IRR stress-tests. In additional to what I call the basic shock analyses, they want to see shocks with both static and dynamic forecasts. They want not only 1-year projections but 2 and 3-year projections as well. Rate ramps are also popular, and they throw in a request for a few non-parallel shifts just for good measure.
I’ve been warning anybody who will listen that this practice is slowly blinding community bankers. With so many different stress-test scenarios and reports to comb through they’re beginning to ignore the information altogether. I’m not saying they should, and I’m not trying to make excuses. It’s just human nature. The deluge of new IRR “requirements” is fueling some pretty serious information overload.
These requests for so many additional stress-tests reek of the “by the book” approach to examinations that the new Kansas City Fed Chief warned us about. Bankers are starting to see the myriad of IRR stress-tests as just another item on the regulator’s checklist. They are beginning to ignore the results altogether.
A telltale sign that this is happening is when the modeling requests themselves become, well (there’s no other word for it)…ridiculous.
We provide to all of our clients a 400bp shock analysis. Or let me clarify, we provide a +400bp shock analysis (i.e. plus 400bp rates up stress-test). We don’t currently run a –400bp shock (i.e. minus 400bp down). In our current environment such a shock makes little sense. As of June 30 the average 1-month rate was 0.05%, and the average 30-year rate was 2.70%. In a –400bp shock down the entire curve would reach a floor of 0.00%. That’s a pretty flat curve indeed! So many modeling assumptions are tied to these rates: repricing spreads, new dollar rates, prepayment tables, early withdrawal tables, decay assumptions, discount rates, etc. I can tell you with certainty that the model (ours or anybody else’s) would likely deliver some pretty strange results. I already don’t even try to analyze too deeply the minus 200bp and minus 300bp shocks for the same reason: the curve is basically flat…at 0.00%.
So, back to the ridiculous part. Despite the fact that a minus 400bp stress-test will most likely produce strange results, we’re being asked to run them anyway. “Our examiners are reviewing our IRR reports and they say we’re missing the –400bp shock Can you please provide that?” Since last fall easily a third of our customers have contacted us with this request. I’m still caught off-guard by the question. What is the value in looking at such a scenario? A –400bp is such a classic case of garbage-in-garbage-out (GIGO) yet neither the client nor the examiner seems to care. It is a clear illustration to me that folks are beginning to tune-out this information. IRR stress-testing can be a very valuable management tool. For many community banks however it’s becoming just another examination check-list item.