Interest Rate Risk in the
Banking Book (IRRBB)
Low interest rate environments all over the world, combined with lessons learned from recent global
financial crisis, forced regulators to refine their rules to cope with Interest Rate Risk in the Banking Book
(IRRBB) as a supplement to the already published Fundamental Review of the Trading Book (FRTB)
which covers similar risks of trading activities. The European Banking Authority (EBA) and the Basel
Committee on Banking Supervision (BCBS) have reviewed their treatments of IRRBB and published own,
independent requirement documents. Other than the EBA guidelines, which become effective already by
January 1st, 2016, the BCBS requirements are still under consultation. These new publications on IRRBB
make it difficult and complex for banks to keep track of the diverging requirements, even intensified by
deviating legal status of both frameworks.
Main elements of future-proof IRRBB business
architecture
IRRBB is currently regulated as part of the supervisory review process and integral part of the internal
capital adequacy assessment process (ICAAP) under a pillar 2 treatment. While EBA focuses on the
refinement of the existing pillar 2 treatment, BCBS brings an additional (hybrid) standardised pillar 1
approach into the discussion, which allows banks to use internally modelled parameters within a given
model for non-maturing products as well as embedded customer optionality. Ultimately, this would lead
for the first time to an explicit minimum capital requirement (MRC) for IRRBB.
„In the current phase of low
interest rates, it becomes
increasingly difficult for banks to
generate sufficient returns, as
their business models often
depend heavily on interest
income.”
Andreas Dombret, member of
board, Deutsche Bundesbank
in: Focus (September 5th, 2015)
Both papers describe requirements for a pillar 2 treatment of IRRBB which are in general quite similar,
with one crucial difference. BCBS explicitly includes credit-spread risk (CSR) in the scope of IRRBB to
avoid any possible incentive for arbitrage between banking – and trading book assignment, whereas EBA
keeps CSR out of scope. Beside providing clarification or more detailing with respect to governance and
(governance) processes as well as to system architecture, the majority of amendments can be found at
methods to be applied for an IRRBB pillar 2 treatment.
FIGURE 1: OVERVIEW OF NEW REGULATION
New Regulation (EBA // BCBS)
Governance
Processes
Methods
IT-Architecture (Data, Systems)
Topic Landscape
• Risk appetite & capital (EBA // BCBS)
– IRRBB should cover both economic value and earnings risk
– Take into account relevant organizational structures
• Risk types (GL2 & GL3 // P1, P5 & MCR)
• Disclosure (GL5 // P8)
• Management reporting (GL4 // P2, P3 & P7)
– Timely and comprehensive reporting systems
– Limit process
• IRR measures (GL2 // P4 & MCR)
– Economic & earnings risk measures
• Simulation & Scenarios (GL3 & GL5 // P4 & MCR)
– Scenarios additional to standard shock
– Economic and planning consistent scenarios
• Modelling (GL4 // P5 & MCR)
– Behavioral modeling
– Validation of assumptions
• System (GL 4 // P6)
Interest
Rate Risk
Strategy
Interest
Rate Risk
Policy
Interest
Rate
Risk &
Limit
Cockpit
Cash Flows
Modeling
Back
testing
Earnings &
Economic
Value
Simulation Calculation
ALM Application
Regulators acknowledge the irresolvable dilemma of not being able to stabilise economic value (EV) and
earnings (NII) simultaneously in case of changes to interest rates.
Therefore, they reinforce the previous requirement of having in place and continuously enhancing IRRBB
measures following EV and earnings approaches, considering all relevant sub-types of IRRBB (repricing
risk, yield curve risk, basis risk, option risk) and using both of them consistently for internal risk appetite
statement, measurement and limit systems (Figure 2 |). In the past banks mainly focused on IRRBB
methods, which measure the (long term) economic value effect of interest rate changes. Now they need
to supplement existing value-based approaches by earnings-based risk measures to reveal also the
(short term) effect on earnings, respectively the banks ability to generate new capital in future.
Furthermore, both regulators emphasize the treatment of customer behaviour in the context of cash
flow modelling. Due to the fact, that the balance sheets of typical (retail) banks show an enormous
amount of non-maturing deposits/loans and further products with embedded client options, these
positions represent a substantial portion of a bank´s IRRBB and need to be treated with adequate
importance. Prudent behavioural modelling of such positions should be reflected to base IRRBB risk
assessment on realistic profiles of future cash flows. (Figure 2 |)
Earnings
To allow for a more precise reflection (simulaFIGURE 2: IRRBB BUSINESS ARCHITECTURE
tion) of continuously changing future economic
Calculation
1
Cash Flows
conditions the regulators accelerate the impleRepricing Gap
mentation of dynamic simulation in addition to
Net Interest Income (NII)
Simulation
2
3
Modelling
already widely used static risk measures. The
Optionality
Earnings at Risk
Scenario
advantage of dynamic models (especially for
Generation
No specific
earning based measures) is their ability to show
repricing dates
PV01
New Business
Assumptions
the impact of changes in conditions for posiCorporate
partial PV01 (time bucket sensitivity)
planning
ongoing
tions and cash flows over time. In doing so, they
CaR / EVE
internal
stress
managetesting
heavily rely on consistently modelled assumpVaR
ment
Backtesting
tions and their correlations to each other. This
means that corporate planning assumptions, assumptions referring to the future shape of interest rate
curves and related FX-rates need to be modelled incorporating typical economic interdependencies.
(Figure 2 |)
Economic Value
Based on the heavy reliance on models for instrument pricing, cash flow calculation and risk measurement, regulators expect banks to have prudent model validation processes in place to assure prompt
corrective actions in case model parameters are proven to lack precision. EBA also claims that a bank is
responsible to provide a sound technical infrastructure for IRRBB measurement and detailed risk analysis
of their banking book positions in a flexible and timely manner, allowing the decomposition of IRRBB to
single risk drivers.
Challenge and BearingPoint Approach
BCBS discusses four approaches to calculate the capital demand in a potential pillar 1 regime of IRRBB.
Therefore, it aims to better understand how banks will be affected by such a regulation. Banks are now
confronted with the challenge not only to develop EBA pillar II compliant IRRBB frameworks and
systems, but also to participate in parallel in BCBS QIS studies to assess future capital demand and to
carry out own analyses to identify levers to impact capital demand, given the hybrid characteristics of
the standardised approach.
BearingPoint can assist its clients with a field-tested delivery model, developed especially to identify,
assess and support the resolution of required refinements of treasury related risk governance, processes,
methodologies and business and system architecture. With our well-structured approach and rich pool of
proven samples and prototypes, which could be easily enhanced we are able to support client activities
with tangible results from the first day until go-live.
About BearingPoint
BearingPoint consultants understand that the world of business changes constantly and that the
resulting complexities demand intelligent and adaptive solutions. Our clients, whether in commercial or
financial industries or in government, experience real results when they work with us. We combine
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Our 3500 people, together with our global consulting network serve clients in more than 70 countries
and engage with them for measurable results and long-lasting success.
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© 2015 BearingPoint GmbH. FC 1040 EN
Contact
Maik Frey
Partner
maik.frey@
bearingpoint.com
Thomas Steiner
Partner
thomas.steiner@
bearingpoint.com