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What’s entailed in an ALM validation and why it matters

Dec 16, 2022

By Alex White and Luke Soper

To meet the Joint Policy Statement on Interest Rate Risk (IRR) and related guidance issued jointly by federal financial regulators, credit unions are required to get regular independent reviews of their asset liability management (ALM) process.

Underlying the IRR guidance is the need for sound risk management practices. Although the specific information issued and the oversight mechanisms used by the relevant agencies (Office of the Comptroller of the Currency, Treasury, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation and National Credit Union Association) may differ, supervisory expectations for IRR management are consistent.

Ultimately, credit union management is responsible for ensuring that the capabilities of the risk management process match the risks being taken. Regulators expect all institutions to manage IRR exposures using processes and systems commensurate with earnings and capital levels, complexity, business models, risk profiles and the scope of operations.

In addition to the review being an important internal control function, it can also provide management with confidence and clarity about the credit union’s overall risk position.

Determine appropriate models

Models can vary significantly depending on complexity, data management and cost. Achieving the proper balance among risk positions, risk measurement processes and cost is critical to a successful model risk management program.

When creating an IRR model or evaluating third-party models, institution management should carefully assess the model’s ability to reasonably capture risks in the institution. Additionally, credit union management should reevaluate the model’s appropriateness as risk positions, strategies and activities change.

While ALM models are commonly used to drive organizational decision-making, they are also sometimes considered black boxes. The inner workings of an ALM model are not always available for inspection and model math can be complicated. ALM models require complex inputs, methodologies and documentation.

Still, the information gained from an ALM validation can help a credit union ensure compliance with regulatory standards, provide management valuable insight to best practices and provide management confidence in the model outputs.

Here are the key elements of the ALM validation process that need to be evaluated for adequacy and appropriateness:

  • ALM policy and governance
  • Source, completeness and accuracy of data inputs into the ALM model
  • Process for developing, reviewing and approving key model assumptions used within the ALM model
  • The supporting documentation for the key model assumptions, such as a historical analysis or a quantitative study
  • IRR measurement system outputs and methodology
  • The backtesting of ALM model results
  • Sensitivity testing of key input assumptions
  • Reporting to the ALM committee and the board of directors
  • Validation value

Not only will an ALM validation check the boxes for the regulatory requirement, it will also add value in other vital ways.

Here’s what you can expect to gain from the process:

  • Recommendations to ensure you are meeting regulatory requirements
  • Best practice recommendations
  • Full confidence in the ALM model and its ability to produce accurate projections
  • High assurance and clarity heading into the next regulatory exam
  • The disappearance of that black box feeling — replaced by the confidence you need to drive organizational decisions

How Wipfli can help

Wipfli specialists can provide your institution with a trusted ALM validation and a full-scale comprehensive overview of your credit union’s ALM process. We’ll provide a review tailored to the type and complexity of your credit union and provide findings on any identified weaknesses as well as a summary of our review. You’ll have access to a team of consultants experienced with all aspects of ALM who can help you navigate through various IRR challenges.

Contact us to learn more about our ALM services.

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Luke Soper, CPA
Senior Consultant
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