On October 21, 2021, the National Credit Union Administration (NCUA) Board approved the Final Rule that officially adds the Sensitivity to Market Risk or “S” component to the CAMEL rating system[1]. This rule is slated to take effect on April 1, 2022 and all examinations after this date will receive an “S” component rating.

The final rule is light on specifics as to how the NCUA will assess the “S” component, but additional guidance is expected prior to the effective date[2]. Outlined in the final rule are three guiding principles for the rating, which include: sensitivity of a credit union’s current and future earnings and economic value of capital to adverse changes in interest rates, management’s ability to identify, measure, monitor, and control exposure to market risk, and the nature and complexity of interest rate risk exposure. Like the other CAMEL ratings, the “S” component will be rated on an ascending 1 through 5 scale, with 1 representing the best achievable rating and 5 being the worst.

The NCUA’s view of interest rate risk (IRR) has likely not changed substantially with the introduction of the “S” component, and it appears likely that inherent balance sheet IRR will continue to be assessed using the NEV supervisory test. As with the current framework, it is expected that higher levels of regulatory scrutiny will come as risk exposure increases.

As important as the level of balance sheet risk is an institution’s risk management framework for IRR. It is also expected that the NCUA’s assessment of risk management will not materially change. Considerations for strong risk management practices, as outlined in supervisory guidance, include:

  • Proper board and senior management oversight with qualified staff, effective committee structure and diverse opinions.
  • Effective policies, procedures, and risk limits that are in-line with the risk appetite of the institution and clearly indicate permissible strategies for managing IRR.
  • Modeling capabilities and management information systems (MIS) commensurate with the risk exposure of the CU. Reports that consider both short-term (NII) and long-term (NEV) risk exposures.
  • Sound internal controls­ with effective oversight of modeling assumptions and regular and meaningful stress tests of key assumptions.

As you prepare for the new “S” component of future exams, it may be worthwhile to consider partnering with an expert to build a sound asset liability management (ALM) program and provide detailed, reliable balance sheet analyses and modeling. A partner with the right expertise may be able to offer the necessary reporting, compliance reviews, “what-if” scenarios, education and personal presentations to satisfy regulatory requirements while helping your cooperative leverage a comprehensive regulatory-satisfying ALM program for stronger, more effective balance sheet management.

[1] The rule also redefines the Liquidity (“L”) component rating to include only liquidity evaluation content and rating criteria

[2] The final rule states that an updated Letter to Credit Unions will be issued to explain the criteria and standards for the “S” Component and how this change will be incorporated into the examination process.

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