Pub. 3 2015 Issue 3

www.uba.org 12 How the Cow Ate the Cabbage: Are Your Interest Rate Risk Reports Giving You the Unvarnished Truth? A s instructive idioms go, “hope for the best but prepare for the worst” is a good one. While recognizing the hu- man tendency for optimistic expectations, it acknowledges the practical contingency that an undesirable outcome may occur. It also exhorts us to be ready for it. For community bankers trying to prepare for a higher interest rate environment, the exercise of modelling the potential risks to earnings and capital is an attempt to do just that. By projecting the changes that happen to interest income and interest expense when the repricing of earning as- sets and paying liabilities occurs in higher rate scenarios, risk managers can quantify the potential results a higher rate climate might produce. In a recently published Range of Practice Memorandum, results of surveys conducted by the Office of the Comptroller of the Currency reveal only a small number of institutions reported elevated levels of interest rate risk. Quite naturally, the reported risk measurements were the surveyed banks’ modelling re- sults, and that’s where hoping for the best collides with preparing for the worst. The Past May Not be Prologue Regulatory authorities, aware that a variety of assumptive inputs are part and parcel of the interest rate risk measurement process, continue to remind us of their expectation that assumptions are reasonable, institu- tion-specific, and supported by empirical evidence. Assumptions, however, despite the efforts expended and resources utilized in their genesis, are still assumptions; their accuracy never comes with a guarantee. In the context of the post-crisis business cycle and economic recovery process, and the manner in which these events and conditions differ from historical patterns, even the reliability of time-tested causal relationships comes into question as a predictor of future behavior. By Lester F. Murray, Associate Partner of The Baker Group LP