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Subject: Investment Securities
Date: April 27, 1998
To: Chief Executive Officers of all National Banks, Department and Division Heads, and all Examining Personnel
Description: Policy Statement
The attached policy statement on investment securities and end-user derivatives activities (1998 statement) was published in the Federal Register by the Federal Financial Institutions Examination Council (FFIEC) on April 23, 1998. The 1998 statement is effective May 26, 1998. The 1998 statement replaces the current interagency policy statement (issued in 1992 as OCC Banking Circular 228).
The 1998 statement outlines effective risk management practices for a bank's securities and end-user derivatives activities. It also describes how risk management principles apply to these activities on a bank-wide basis and within specific risks. Investment and end-user derivative activities play an integral part in determining a bank's interest rate risk profile. The 1998 statement should be viewed within the broader context of the "Joint Interagency Policy Statement on Interest Rate Risk" (issued in 1996 as OCC Bulletin 96-36).
The agencies expect institutions to understand the price sensitivity of securities before purchase (pre-purchase analysis) and on an ongoing basis. In addition, to properly assess exposure to interest rate risk, institutions should understand the price sensitivity of the aggregate investment portfolio. Although still recommended for banks, the "high risk" test for mortgage derivative products (MDPs), which the OCC previously established in the 1992 statement, will no longer limit a bank's ability to purchase these assets.
These policy changes reflect the agencies' risk-based supervision approach and their intention to view bank assets in the context of bank-wide management of portfolio and interest rate risk. The elimination of the "high risk" test as a constraint on a bank's purchase activity should not be interpreted as an indication that the OCC believes high risk MDPs, or other securities with similar or greater price sensitivity, are appropriate investments for all financial institutions. Whether a security, MDP or other instrument, is an appropriate investment depends upon a variety of factors, including the institution's capital level, the security's impact on the aggregate risk of the portfolio, and management's ability to measure and manage bank-wide interest rate and liquidity risks. As a matter of sound practice, national banks should continue to perform quantitative tests on their MDP purchases, to ensure that they thoroughly understand the accompanying cash flow and interest rate risks. Examiners will evaluate the propriety of national banks' purchase of MDPs formerly designated as "high risk" as well as other securities with similar interest rate sensitivity, within the context of the sound practices guidance outlined in the attached FFIEC policy statement.
Institutions should, as a matter of sound practice, demonstrate an understanding of price sensitivities for all securities. Although securities with complex options features and extended maturities generally warrant more formal reviews than less complex securities, each national bank should identify, as part of its own investment policy or procedures, the types of securities for which documented stress testing is required.
For more information, contact Kurt Wilhelm, National Bank Examiner, or J. Ray Diggs, National Bank Examiner, Treasury and Market Risk Division, (202) 874-5670.
Emory W. Rushton