Interest-Rate Risk in the Banking Book (IRRBB)

The management of interest-rate risk in the banking book (IRRBB) has been increasing in importance since 2004, shown by the increased frequency and scale of regulatory requirements. With its “Principles for the management and supervision of interest rate risk” (BCBS 108), the Basel Committee on Banking Supervision (BCBS) addressed interest-rate risks arising from non-trading transactions at both credit institutions and investment firms. The revised guidelines (BCBS 368) were published in April 2016 and corresponding EU requirements have been regularly revised and expanded.

In July 2018, the European Banking Authority (EBA) published its latest, revised guidelines (GL) on the management of IRRBB (EBA/GL/2018/02), which, together with expected revisions to the Capital Requirements Regulation & Directive (CRR/CRD) and the resulting EBA mandates for technical standards, should implement the latest BCBS standards. The EBA GL form part of a larger review of Pillar-2 measures, which include revisions to GL on the revised common procedures and methodologies for the supervisory review and evaluation process (SREP) and supervisory stress testing (EBA/GL/2018/03) and to GL on institutions’ stress testing (EBA/GL/2018/04). The EBA sets out the supervisory authorities' expectations of the IRRBB's measurement, management and governance arrangements and its consideration in the internal capital adequacy assessment process (ICAAP).

In addition to reflecting the developments of the BCBS standards, the revised GL clarify the requirements for internal control and the regulatory outlier tests. New definitions have been included in the GL as well as detailed requirements for the allocation of capital for IRRBB to provide for unfavourable developments in the economic value of equity (EVE) and net interest income (NII). In addition, supervisors must be informed, as an "early warning signal", if the decline in EVE exceeds 15% of core capital. There are new rules for an appropriate assessment of the interest-rate risk of new products in the banking book (e.g. interest-rate derivatives), provisions on currency-specific shocks for material currencies, an explicit provision for institutions to consider negative interest rates in low interest-rate environments and the integration of six shock scenarios for the outlier test proposed by the BCBS. In addition, credit-spread risk in the banking book (CSRBB) must now be identified, measured, monitored, and controlled.

The EBA IRRBB guidelines replace the previous EBA guidelines published in May 2015 (EBA/GL/2015/08) and apply from 30 June 2019 with transitional provisions until 31 December 2019. Once the translations have been published, competent authorities have two months to confirm their plans to adopt the new guidelines or explain clearly why they do not plan to comply. The short-term nature of the implementation makes it clear how important the new GL are for supervision.

The German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht - BaFin) has only recently implemented the previous EBA/GL/2015/08 with its current Circular 9/2018 on the subject. There is still no response to the new guidelines. Amendments resulting from the latest BaFin circular include the abolition of the "alternative procedure”, which is likely to be of importance for smaller banks. A transitional period in line with the BaFin’s “Minimum Requirements for Risk Management” (Mindestanforderungen an das Risikomanagement – MaRisk) was granted until 31 October 2018. From this date onwards, banks will have to measure and report interest-rate risks from both an economic-value and an earnings-oriented perspective.

The BearingPoint Abacus360 module for the management of IRRBB measures the risk via the economic-value perspective, considering the long-term effect of interest-rate changes. The current market value of the interest-rate book is determined by discounting the future cash flows with the current interest-rate curves. Instead of the interest margin (as with the earnings-oriented approach), the focus is on the present value of the interest-rate book. The module can calculate the four major interest-rate risks: option risk, repricing risk, yield-curve risk and basis risk, all of which (including in combination) can lead to falling interest margins and corresponding economic-value effects:

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