C. Myblog

Concentration Limits and Interest Rate Risk – a Moving Target

December 19, 2013

Over the last few years, many credit unions have been asked to complete concentration risk policies and develop limits founded on some type of analysis.  Some institutions have also included limits in their policy designed to mitigate exposure to interest rate risk as a supplement to more traditional asset/liability management practices.  These limits should be carefully reviewed to ensure that they are still appropriate, given any potential changes that may have occurred in the credit union’s financial structure.

The nature of concentration risk limits is that they are designed to limit too much risk from any single exposure, or group of exposures, that could threaten the viability of the credit union.  Mortgage-related assets are often cited as an area that should be constrained through a concentration limit.  However, the nature of interest rate risk and asset/liability management is significantly more complicated than a single limit can capture.

Concentration risk limits designed to mitigate interest rate risk often fall short of helping to manage the overall asset and liability mix of the credit union.  Interest rate risk and asset/liability management (even as the name implies) involves more than just assets, and limits designed to mitigate interest rate risk exposures should be tested regularly as the changing mix of both assets and liabilities can have a material impact on the interest rate risk profile of the credit union.  It is this interconnectedness of the overall financial structure that makes concentration risk limits designed to mitigate interest rate risk exposures difficult to test to ensure they are appropriately managing risk.  Instead of setting individual limits, test the entire structure, in aggregate, to ensure that the overall enterprise does not have too much interest rate risk.  This aggregate monitoring of interest rate risk is a cornerstone to sound asset/liability management, and should not be overlooked in favor of concentration risk limits to quantify interest rate risk exposures.

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