In its May 2021 meeting, the National Credit Union Administration (NCUA) Board approved a final rule that amended its derivatives rule. A derivative is “a financial contract which derives its value from the value and performance of some other underlying financial instrument or variable, such as an index or interest rate[.]” The final rule was published in the Federal Register on May 26, 2021 and will be effective June 25, 2021.
Subpart B of Part 703 of NCUA’s rules and regulations explains a federal credit union’s authority to use derivatives to manage interest rate risk. NCUA notes that interest rate risk “refers to the current and prospective risk to a credit union’s capital and earnings arising from movements in interest rates.” In its Examiner’s Guide, NCUA explains why interest rate risk is problematic:
“When interest rates change, the present value and timing of future cash flows may change. This, in turn, changes the underlying value of a credit union’s assets, liabilities, and off-balance-sheet items and thus its overall net economic value. Changes in interest rates also affect a credit union’s earnings by altering interest rate-sensitive income and expenses, which affects its net interest income. Excessive IRR can present a significant threat to a credit union’s current capital and projected earnings if not managed appropriately.”
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