Circular
New Supervisory Policy Statement on Investment Securities and End-User Derivatives Activities
May 11, 1998
Circular No. 11055

Effective May 26, 1998

To All State Member Banks, Bank Holding Companies, and Branches
and Agencies of Foreign Banks, in the Second Federal Reserve District:

The following is from an announcement by the Federal Financial Institutions Examination Council (FFIEC) regarding a revised policy statement by the FFIEC agencies (the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the National Credit Union Administration) on sound practices for managing the risks of investment securities and end-user derivatives activities:

The federal depository institution regulatory agencies, acting jointly through the Federal Financial Institutions Examination Council (FFIEC), published the Supervisory Policy Statement on Investment Securities and End-User Derivatives Activities (1998 Statement). The 1998 Statement provides guidance on sound practices for managing the risks of investment activities, with a particular emphasis on market risk (primarily interest rate risk).

In adopting the 1998 Statement, the agencies are rescinding the Supervisory Policy Statement on Securities Activities published on February 3, 1992. This action eliminates the constraints on investing in mortgage derivative products (MDPs) that are deemed "high risk" under existing supervisory guidance. The decision to eliminate such constraints does not indicate that the regulatory agencies believe that MDPs currently identified as "high risk" are appropriate or inappropriate investments. Rather, the decision reflects the view that the appropriateness of any investment product must be evaluated using a variety of factors, especially management's ability to measure and manage the risks of investment activities. The 1998 Statement reflects the risk-based approach to supervision adopted by the financial institution supervisors, as well as the intent to encourage financial institutions to evaluate and control the risks associated with investment activities more on an investment portfolio or institution-wide basis.

As a matter of sound practice, financial institutions should understand the risks inherent in their securities activities, both prior to purchase and on an ongoing basis. The agencies continue to believe that the stress testing of MDP investments, as well as other investments, has significant value for financial institutions' management of risk.

The revised policy statement will become effective on May 26, 1998. The FFIEC's official notice of this statement, as published in the Federal Register of April 23 is available as a file (pdf - 53kb). Questions on this matter should be directed to the Federal Reserve Board, as specified in the notice.