It is essential that banks' interest rate risk policies and procedures be clearly defined and consistent with the nature and complexity of their activities. These policies should be applied on a consolidated basis and, as appropriate, at the level of individual affiliates, especially when recognising legal distinctions and possible obstacles to cash movements among affiliates.

1. Banks should have clearly defined policies and procedures for limiting and controlling interest rate risk. These policies should be applied on a consolidated basis and, as appropriate, at specific affiliates or other units of the bank. Such policies and procedures should delineate lines of responsibility and accountability over interest rate risk management decisions and should clearly define authorised instruments, hedging strategies and position-taking opportunities. Interest rate risk policies should also identify quantitative parameters that define the level of interest rate risk acceptable for the bank. Where appropriate, such limits should be further specified for certain types of instruments, portfolios, and activities. All interest rate risk policies should be reviewed periodically and revised as needed. Management should define the specific procedures and approvals necessary for exceptions to policies, limits and authorisations.

2. A policy statement identifying the types of instruments and activities that the bank may employ or conduct is one means whereby management can communicate their tolerance of risk on a consolidated basis and at different legal entities. If such a statement is prepared, it should clearly identify permissible instruments, either specifically or by their characteristics, and should also describe the purposes or objectives for which they may be used. The statement should also delineate a clear set of institutional procedures for acquiring specific instruments, managing portfolios, and controlling the bank's aggregate interest rate risk exposure.

Principle 5:

It is important that banks identify the interest rate risks inherent in new products and activities and ensure these are subject to adequate procedures and controls before being introduced or undertaken. Major hedging or risk management initiatives should be approved in advance by the board or its appropriate delegated committee.

3. Products and activities that are new to the bank should undergo a careful pre-acquisition review to ensure that the bank understands their interest rate risk characteristics and can incorporate them into its risk management process. When analysing whether or not a product or activity introduces a new element of interest rate risk exposure, the bank should be aware that changes to an instrument's maturity, repricing or repayment terms can materially affect the product's interest rate risk characteristics. To take a simple example, a decision to buy and hold a 30 year treasury bond would represent a significantly different interest rate risk strategy for a bank that had previously limited its investment maturities to less than 3 years. Similarly, a bank specialising in fixed-rate short-term commercial loans that then engages in residential fixed-rate mortgage lending should be aware of the optionality features of the risk embedded in many mortgage products that allow the borrower to prepay the loan at any time with little, if any, penalty.

4. Prior to introducing a new product, hedging, or position-taking strategy, management should ensure that adequate operational procedures and risk control systems are in place. The board or its appropriate delegated committee should also approve major hedging or risk management initiatives in advance of their implementation. Proposals to undertake new instruments or new strategies should contain these features:

• a description of the relevant product or strategy;
• an identification of the resources required to establish sound and effective interest rate risk management of the product or activity;
• an analysis of the reasonableness of the proposed activities in relation to the bank's overall financial condition and capital levels; and
• the procedures to be used to measure, monitor and control the risks of the proposed product or activity.