WASHINGTON — Though there is growing concern that interest rate increases will catch banks off guard, regulators are split on how big the threat is.
In interviews, some regulators predicted rising rates will take a significant chunk out of earnings, while others said they expect minimal damage.
Both viewpoints will get an airing Friday at a symposium hosted by the Federal Deposit Insurance Corp.
"You have losses occurring in the loan portfolio on the asset side. When you compound that with the rising rate environment and compressing margins, that could create a situation where you're having even greater depression of earnings," said Charles Vice, the commissioner for the department of financial institutions in Kentucky. "Do we have a lot of banks that this could potentially cause to fail? No. Do we have a lot of banks that this would compress their earnings stream and make it more difficult to augment capital? Yes."
But while other regulators agreed banks must focus on the potential for interest rate risk, they are not sounding any alarms. "If interest rates move sharply, the impact could be very substantial. But I want to emphasize that that is 'if' interest rates move sharply," said William Haraf, the banking commissioner in California. "It's just a generic concern."
Unprecedented low short-term rates have made cheap funding attractive. But with most analysts expecting the federal funds rate — now hovering between zero and 0.25% — to return to normal later this year, many have warned that some institutions could struggle adjusting their balance sheets if they are not ready.
A joint agency advisory earlier this month said institutions should test their interest rate risk management using computer modeling and stress-testing.
George French, the deputy director of policy in the FDIC's division of supervision and consumer protection, said while regulators are not predicting a "crisis situation," there are some institutions that "do appear to be getting a little more extended on interest rate risk."
"There is a subset of institutions that seem from off-site" monitoring "to have a longer-maturity asset profile and many of them probably … have shorter-term liabilities," said French, whose agency has been the most vocal in warning about problems posed by interest rate risk.
"At this point, we don't see this as a systemic or significant banking wide problem. … This type of exposure that we're seeing is not unprecedented. But we are in a fairly unusual position with short-term rates being as low as they are. … That elevates the attention that needs to be given to this issue."
But even though regulators are urging banks to be aware of the impact of higher rates, it is unclear whether they believe there will be serious repercussions.
Kerri Corn, an official with the Office of the Comptroller of the Currency, called the agencies' joint advisory "a shot across the bow."
"We started off the guidance saying, 'We understand you take on interest rate risk. It's what you do. It's part of your business. Just do it wisely,' " said Corn, the director of market risk in the OCC's credit and market risk division. "Do we see it as a big issue right now? We do not."
Corn said regulators can track levels of interest rate risk through regular monitoring. Interest rate risk is included in the standard scorecard for assessing an institution's health during an examination — known as its Camels rating — which includes a factor gauging "sensitivity to market risk."
"We don't see it as a systemic issue at all. This is a reminder … that it's not all about credit risk and liquidity risk. Don't forget about interest rate risk."
Even Vice, the Kentucky commissioner, said he remains more worried about asset quality.
"Most of our banks would be able to weather an impact to earnings with rates increasing a lot better than they've been able to absorb some of these asset-quality problems," he said.
But since institutions are already wrestling with so many issues stemming from the financial crisis, interest rate risk could prove to be the proverbial straw that breaks the camel's back, Vice said.
"In the current economic environment," interest rate risk "would be a widespread problem, in the sense that we're already in a situation where industry earnings are depressed," he said. "To add any factors that negatively impact them further is a concern.
"This is something that the entire industry needs to look at, be cognizant of and manage to make sure that it doesn't have a significant negative impact if we do get changes in interest rates."
Regulators are, however, united in how banks should address interest rate risk. They are urging banks with disproportionate levels of short-term funding and long-term assets to recalibrate.
"Banks, when they realize they have a mismatch, can replace investments that roll off through organic growth with shorter-term investments," said Kyle Hadley, the chief of examination support in the FDIC's division of supervision and consumer protection. "They could also try to extend their funding profile, issuing longer-term CDs or obtaining longer-term borrowings. If the bank is capable of certain reasonable interest rate risk hedging, we're not discouraging that if it is within their means."
But a recalibration should not be a hurried process, Hadley said.
"We don't want banks to recklessly go and adjust their balance sheet," he said. "We want it to be a managed process."
Corn said institutions should already have systems in place for measuring interest rate risk.
"What we do during our exam process is look to make sure their overall systems and controls make sense, based on a bank's interest rate risk and overall risk profile," she said. "We would look to see: … how are you measuring risk, what are your risk limits, has your board signed off?"
Vice said an institution can have some imbalance between the maturities for assets and those for liabilities, but it needs to be contained.
"I'm not saying I want a bank to be perfectly matched assets-to-liabilities … but they need to be cognizant if they have a big disparity," he said.