By Julie Stackhouse, Executive Vice President
This post is part of a series titled “Supervising Our Nation’s Financial Institutions.” The series, written by Julie Stackhouse, executive vice president and officer-in-charge of supervision at the St. Louis Federal Reserve, appears at least once each month.
Last month, we addressed the examiner's process for reviewing and rating bank liquidity. This month, we examine the sixth and final component of the safety and soundness rating system for banks (called CAMELS): sensitivity to market risk. The first component that we addressed was capital adequacy, followed by asset quality, management, earnings and liquidity. See Stackhouse, Julie. “The ABCs of CAMELS.” St. Louis Fed On the Economy, July 24, 2018.
Sensitivity to market risk is defined by regulators as the degree to which changes in interest rates, foreign exchange rates, commodity prices or equity prices can adversely affect a bank’s earnings and, in turn, its financial health. For many banks—and especially community banks—interest rate risk is the predominant market risk they face.
In general, banks must manage four types of interest rate risk: Gray, Doug. “Interest Rate Risk Management at Community Banks.” Community Banking Connections, Third Quarter 2012.
If a bank fails to manage these risks adequately, its earnings, capital and liquidity can be damaged.
During their review, examiners determine the level of sensitivity to market risk posed by the bank’s assets and liabilities and assess its potential impact on capital and earnings. This assessment includes both quantitative and qualitative components, including:
As with other components in the CAMELS rating system, sensitivity to market risk is assigned a rating of 1 to 5. Organizations with ratings of 3, 4 or 5 will be expected to take action to strengthen their management of market risk.
1The first component that we addressed was capital adequacy, followed by asset quality, management, earnings and liquidity. See Stackhouse, Julie. “The ABCs of CAMELS.” St. Louis Fed On the Economy, July 24, 2018.
2 Gray, Doug. “Interest Rate Risk Management at Community Banks.” Community Banking Connections, Third Quarter 2012.
3 A yield curve is a line on a graph that plots interest rates of similar financial instruments at differing maturity dates.