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July 2008 Report No. AUD-08-011 DSC’s Examination Assessment of Interest Rate Risk AUDIT REPORT Report No. AUD-08-011 July 2008 DSC’s Examination Assessment of Interest Rate Risk Federal Deposit Insurance Corporation Audit Results Why We Did The Audit For the 38 sampled risk management examinations we reviewed, FDIC examiners generally complied with applicable policies and procedures for assessing and addressing an institution’s The audit objectives were to internal control, review, and audit coverage of the interest rate risk management process. (1) determine whether the FDIC’s Generally, as depicted in the figure below, we found: examinations comply with applicable policies and procedures for assessing • Pre-Examination Planning memoranda listed the red flags identified by the FDIC’s Interest and addressing an institution’s Rate Risk Standard Analysis software application; and internal control, review, and audit • Reports of Examination and supporting working papers showed that examiners either coverage of the interest rate risk obtained for consideration a copy of the institution’s independent review report or management process; and identified a contravention of the IRR SOP. (2) evaluate the corrective actions pursued when significant weaknesses Regarding the pursuit of corrective actions, we found ...
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July 2008 Report No. AUD-08-011
DSC s Examination Assessment of Interest Rate Risk          
AUDIT REPORT
 
 
 
Report No. AUD-08-011 July 2008  DSC’s Examination Assessment of Interest Rate Risk  Audit Results  For the 38 sampled risk management examinations we reviewed, FDIC examiners generally complied with applicable policies and procedures for assessing and addressing an institution’s internal control, review, and audit coverage of the interest rate risk management process. Generally, as depicted in the figure below, we found:  red flags identified by the FDIC’s InterestPre-Examination Planning memoranda listed the Rate Risk Standard Analysis software application; and  Reports of Examination and supporting working papers showed that examiners either obtained for consideration a copy of the institution’s independent review report or identified a contravention of the IRR SOP.  Regarding the pursuit of corrective actions, we found that informal and formal corrective actions generally addressed significant weaknesses reported by examiners in the area of interest rate risk. We also noted that a provision related to interest rate risk was sometimes not included in corrective actions, even though both the composite and Sensitivity to Market Risk component ratings of the institutions by examiners were less than satisfactory. However, DSC showed that provisions addressing other ratings components reasonably addressed the identified concerns.  We also identified situations where the examiner’s assessment of an institution’s independent review and reporting to the institution’s board of directors could be improved. Specifically, we found that examinations often did not:  provide conclusions on the adequacy of the independent review functions, or  assess the adequacy of the institution’s reporting on the independent reviews to its board.  Additionally, training records we reviewed for 42 interest rate risk and capital markets Subject Matter Experts and Regional Specialists showed that some had obtained little or no training in recent years in their areas of expertise. Targeted training could enhance the contribution of these experts and specialists to the examination process.  Ensuring that appropriate institution and examination controls and resources are in place will help the FDIC to assure that an institution’s interest rate risk management processes are appropriate and functioning adequately. Audit Results of Sample Analysis
             Federal Deposit Insurance Corporation Why We Did The Audit  The audit objectives were to (1) determine whether the FDIC’s examinations comply with applicable policies and procedures for assessing and addressing an institution’s internal control, review, and audit coverage of the interest rate risk management process; and (2) evaluate the corrective actions pursued when significant weaknesses are reported by examiners. Interest rate risk, the exposure of an institution’s earnings and capital to adverse interest rate changes, is fundamental to the business of banking. The audit focused on FDIC-supervised institutions with indicators of elevated interest rate risk.  Background  Changes in interest rates can adversely affect a financial institution’s earnings and market capital. The FDIC’s Division of Supervision and Consumer Protection (DSC) conducts periodic risk management examinations to ascertain, among other things, an institution’s Sensitivity to Market Risk, including interest rate risk.Pre-examination Planning Memoranda DSC has issued guidance forLis ted Red Flags conducting these examinations.Independent Reviews Obtained or 97% Contravention Cited  Additionally, theJoint Agency Policy84% Interest Rate Risk Provisions Statement on Interest Rate Risk(IRR in Corrective Actions88% Included SOP), issued by the FDIC and the61% Adequacy of Independent Review other federal banking agencies,32% Functions Determined provides guidance to institutions on Review Reporting to71% Independent prudent interest rate risk managementBoard Assessed principles and assists bankers andlapSigno 2d%e0R snatains OblisteciaejbuSrtpeExr teat MctnI teretR denece0%40%60%80s%t100% examiners in evaluating the adequacyRate Risk Training of an institution’s management ofSource: OIG sample analysis.  interest rate risk. The IRR SOP states  that an institution’s interest rate riskRecommendations and Management Response management process should be subject to periodic independent review to ensure the integrity, tWhee  ardeecqoumacmye nodf eadn  tihnastt itDuStiCo nesm ipnhdaesipzeen tdoe netx raemviienewr sa tnhde  onne tehde t oa dfeuqlluya casys oefs sr eapnodr tcionng colun dteh eo n accuracy, and reasonableness of the independent review to the bank’s board, as warranted by risk; advise examiners of the institution’s overall risk management importance of collectively considering all relevant examination guidance; and establish policies process. Overall, the purpose of the and guidelines for the training of interest rate risk and capital markets Subject Matter Experts independent review is to ensure that the interest rate risk measurement and raensdp oRnesgiivoen aalc tSiopne.c ialists.  Management concurred with our recommendations and is taking management processes are sound. To view the full report, go toper8strovog.002/fdw.igicwwa.ps
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Contents Page    BACKGROUND  Institution Guidance in the Statement of Policy on Interest Rate Risk  FDIC Examination Guidance  RESULTS OF AUDIT  EXAMINER ASSESSMENT OF AN INSTITUTION’S INDEPENDENT REVIEW AND REPORTING TO THE BOARD OF DIRECTORS  Joint Agency Statement of Policy on Interest Rate Risk  Examination Guidance Related to the Independent Review      Examiner Determination of the Adequacy of Independent Reviews      Examiner Assessment of an Institution’s Reporting to Its Board of  Directors on the Independent Reviews      Examiner Implementation of Guidance on Independent Reviews      Reliance on Independent Reviews and Management Systems  Recommendations on Examiner Assessment of an Institution’s  Independent Review and Reporting to the Board of Directors  INTEREST RATE RISK TRAI NING FOR SUBJECT MATTER EXPERTS AND REGIONAL SPECIALISTS  Training Guidance  Subject Matter Expert and Regional Specialist Training  Establishment of Policy for Continuing Education  Maintenance of Human Capital Resources      Recommendation on Interest Rate Risk Training for Subject Matter  Experts and Regional Specialists  CORPORATION COMMENTS AND OIG EVALUATION  APPENDICES  1. OBJECTIVES, SCOPE, AND METHODOLOGY  2. CORPORATION COMMENTS  3. MANAGEMENT RESPONSE TO RECOMMENDATIONS  4. ACRONYMS USED IN THE REPORT  TABLE Scope and Annual Reporting Expectations for an Institution’s Independent Review        FIGURE Examination Conclusions Not Provided on the Scope of the Independent Reviews  
 
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Office of Audits Office of Insector Gener al
Federal Deposit Insurance Corporation 3501 Fairfax Drive, Arlington, VA 22226  DATE: July 7, 2008  MEMORANDUM TO: L. Thompson, Director Sandra  Division of Supervision and Consumer Protection    /Signed/ FROM:Russell A. Rau  Assistant Inspector General for Audits  SUBJECT:DSC’s Examination Assessment of Interest Rate Risk     (Report No. AUD-08-011)   This report presents the results of our audit of the Division of Supervision and Consumer Protection’s (DSC) examination assessment of interest rate risk at FDIC-supervised institutions. The audit objectives were to (1) determine whether the FDIC’s examinations comply with applicable policies and procedures for assessing and addressing an institution’s internal control, review, and audit coverage of the interest rate risk management process; and (2) evaluate the corrective actions pursued when significant weaknesses are reported by examiners.1 We focused the audit on those FDIC-supervised institutions with indicators of elevated interest rate risk. We conducted this performance audit in accordance with generally accepted government auditing standards. Appendix 1 of this report discusses our audit objectives, scope, and methodology in detail.   BACKGROUND  Interest rate risk is fundamental to the business of banking. Changes in interest rates can expose an institution to adverse shifts in net interest income, increase the cost of funds, and impair the underlying value of its assets, thereby adversely affecting an institution’s earnings and market capital. The FDIC is responsible for ensuring that the financial institutions it supervises operate in a safe and sound manner. To accomplish this, the FDIC conducts risk management examinations to ascertain, among other things, an institution’s Sensitivity to Market Risk, including interest rate risk. This assessment is summarized in an assigned risk rating for Sensitivity to Market Risk, which is the “S”  
                                                          1The FDIC generally initiates informal or formal corrective action against institutions with a composite safety and soundness rating (see footnote 2) of “3,”“4,” or “5,” unless specific circumstances warrant otherwise.   
 
  
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