The simplest definition of eve is the net present value npv of a banks balance sheets cash flows. Measurement of banks exposure to interest rate risk. Interest rate risk in banking book irrbb refers to the current or prospective risk to a banks capital and earnings arising from adverse movements in interest. What is interest rate risk in the banking book irrbb. Whitepaper interest rate risk in the banking book irrbb. The impact of interest rate risktaking on a banks profitability. Banking book all financial instruments, on and off balance sheet, excluding those that are part of the trading book. The basel comittee on banking supervision bcbs made new guidelines for regulations available in april 2016. However, from an earnings point of view, there cannot be an interest rate loss from investing equity in fixed rate assets in order to stabilize earning flows. The credit risk component is based on the same conceptual framework as basel ii and the main commercially available credit risk models. The risk that assets and liabilities reprice or mature at different times, causing margins between interest income and interest expense to narrow. The panel of participating banks was a balanced mix of significant entities under ecb. The first day will look at the complexity of irrbb including sessions focusing on irr metrics, risk.
Mar 28, 2012 interest rate risk in the banking book understanding the fundamentals of irrbb and how it differs from interest rate risk in the trading book event start date. Interest rate risk in the banking book irrbb irrbb overview interest rate risk in the banking book irrbb is the risk to earnings or capital arising from movement of interest rates. It generally arises from repricing risk, risks related to the timing mismatch in the maturity and repricing of assets and liabilities and off. This paper looks at the standards from a practical implementation point of view and raises some of the main challenges. The committees most recent release on this topic forms part of the proposed new basel capital accord the new. October 1979 to october 1982, nonborrowed reserves target regime. Its aim is to identify earnings volatility over a 12monthhorizon against the two instantaneous parallel shock scenarios. Interest rate risk lets say a treasury bond offers a 3% coupon rate, and a year later market interest rates fall to 2%. This chapter describes requirements on assessing interest rate risk in the banking book, ie the current or prospective risk to a bank s capital and to its earnings, arising from the impact of adverse movements in interest rates on its banking book. Table a for qualitative information and table b for the. Net interest margin interest income interest expense earning assets of a bank is a function of the interest rate sensitivity, volume and mix of its earning assets and liabilities.
In general terms, the principles refer to 1 the role played by administration in the supervision of interest. It is important to note the advantage of using independent principal components. Sources of irrbb include interest rate gaps, basis risk, yield curve risk and option risk. Interest rate risk in the banking book 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. These guidelines on managing interest rate risk in the banking book are intended to provide guidance on designing the strategies and processes required for identifying, measuring, controlling and monitoring interest rate risks in the banking book. Nii, on the other hand, is always based on cash flows at client rates and thus represents total nii. The low interest rate environment has made interest rate in the banking book irrbb an interesting topic. The analytical var for interest rate risk in the banking book can be calculated as follows. Disclosure two annual reports are required for public disclosure. If you sell the 3% bond before it matures, you will probably find that its price is higher than it was a year ago.
For example, if rates were to increase and a banks deposits repriced sooner than its loans, it could result in the bank paying out more interest on deposits than the interest it is receiving from loans. Learn how to evaluate interest rate risk in the banking book and its impact on a banks balance sheet and earnings. Interest rate risk in the banking book irrbb is part of the basel capital framework under pillar 2 and principles for the management and supervision of interest rate risk were set out in 2004 by the bcbs. We examine the impact of a bank s interest rate risk appetite on its return on equity, as well as give insight in the impact of a direct capital charge for irrbb. Guidelines on the management of interest rate risk arising from nontrading book activities 4. Interest rate risk in the banking book over the past decade the basel committee on banking supervision the basel committee has released a number of consultative documents discussing the management and supervision of the interest rate risk inherent in a bank s balance sheet1. Interest rate risk in the banking book is the risk posed by adverse movements in interest rates that cause a mismatch between the rates banks set on customer loans and on deposits. The basel committee on banking supervision has today issued standards for interest rate risk in the banking book irrbb. Interest rate risk in the banking book in 2015, two documents were published that will have a significant impact on the risk management framework of banking institutions. The net value of options under the interest rate interest rate shock scenario should be calculated using the new yield curve under. Irrbb interest rate risk in the banking book slideshare. Andreas dombret, member of board, deutsche bundesbank in. Deutsche bank annual report 2017 nontrading market risk.
Banking book irrbb is the risk to earnings or value and in turn to capital arising from movements of interest. Interest rate risk in the banking book is the current or prospective risk, to both the groups capital and earnings, arising from movements in interest rates, which affect the groups banking book exposures. With the interest rate risk of the banking book, the basel committee on banking supervision bcbs 1 aims primarily to address the potential loss of economic value of institutions from a change in the interest rates called irr and credit spread risk csr in the banking book 2. For the purpose of the exercise, the expected passthrough rate was defined as the proportion of a market interest rate change that the bank will pass on to its customers in order to maintain the same level of stable deposit balances under a certain ir shock. The way credit and interest rate risk are modelled individually is in line with standard practices. Return of interest rate risk exposures in the banking book irrbb supplementary information form mabs12ib introduction 1.
The measure is effective at highlighting those institutions with high irr. Interest rate risk is an integral part of banking business, and may even be a source of profit. This return collects supplementary information on the weighted average interest costs of interest bearing rate sensitive liabilities denominated in hong kong dollars of authorized institutions on a monthly basis. Jun 25, 2019 this is a longterm economic measure used to assess the degree of interest rate risk exposure. Interest rate risk in the banking book marcus evans. At worst, there could be an opportunity loss, but always. Interest rate risk in the banking book, written by industry expert paul newson, provides a thorough guide to the new regulatory requirements surrounding irrbb and demonstrates the importance of good governance the author explains the nature of interest rate risks in simple language, describing the methods typically used to measure them, with the added advantage of many worked examples. May 14, 2010 interest rate risk explained the amount at risk is a function of the magnitude and direction of interest rate changes and the size and maturity structure of the mismatch position.
Interest rate risk in the banking book irrbb is currently part of the basel capital frameworks pillar 2. The tradeoff between delta eve and delta nii by philip j. Interest rate risk in the banking book how to manage. Irrbb interest rate risk in the banking book a bearingpoint accelerator eba and the basel committee reacted to the current low interest. Standards on the interest risk in the banking book irrbb. Meeting the practical challenges highlights the new basel committee on banking supervision bcbs standards for irrbb come into force january 1, 2018. The basel committee issued revised standards for interest rate risk in the banking book in april 2016 and in 2018 they will expect organisations to be compliant. Sensitivity analysis of irrbb stress test 2017 final results. Institutions should treat irrbb as an important risk and always assess it explicitly and. Its aim is to identify earnings volatility over a 12monthhorizon against the two instantaneous. Hence, when there is a variation in the interest rate, we can easily analyze the influence of the variation on the total interest income of the bank. Video would be covering about regulatory of interest rate risk in banking books.
In recent years, interest rate risk in the banking book irrbb has moved up the priority list for regulators. Introduction interest rate risk in the banking book or irrbbas defined by the basel committeeis the current or prospective risk to a banks capital and earnings, arising from adverse movements in interest rates that affect. The committees most recent release on this topic forms part of the proposed new basel capital accord. Increases importance of measuring and managing interest rate risk. Interest rate risk in the banking book 2019 5th annual.
Determinants of irr for cubs include the size of the entity, the level of capital, the level of call deposits and the interest rate spread. Irrbb deals with the risks associated with a change in interest rates, and affecting a bank s banking book, as opposed to its trading book. Guidelines on the management of interest rate risk arising from nontrading book activities 2 abbreviations alco asset and liability management committee alm asset and liability management bcbs basel committee on banking supervision bsg banking stakeholder group cet1 common equity tier 1 csrbb credit spread risk from nontrading book activities crd capital. These standards are intended to replace an earlier guidance set out in the 2004 principles for the management and supervision of interest rate risk4, which laid out the principles and the methods expected to be used by banks for measuring, managing, monitoring and. In the present value perspective, the risk is quantified as an economic value change of the total banking book cash flow in case of changes in the yield curve. Interest rate risk in the banking book irrbb definition. A change in interest rate has direct impact on their market value. Guidelines on the management of interest rate risk arising. We examine the impact of a banks interest rate risk appetite on its return on equity, as well as give insight in the impact of a direct capital charge for irrbb. In may 2015, the european banking authority eba published an update to the guidelines for managing interest rate risk in the banking book irrbb. Irrbb includes potentially adverse effects on earnings, capital, or both.
Interest rate risk in the banking book responses of participating banks were collected on an individual basis through an online survey3 and then combined in order to produce a consolidated view4. Mar 18, 2020 occ flags rising interest rates as key bank risk uncertainty around how bank deposits will react to a rising interest rate environment was among several key risk themes identified by the occ in its semiannual risk perspective report released today. The standards revise the committees 2004 principles for the management and supervision of interest rate risk, which set out supervisory expectations for banks identification, measurement, monitoring and control of irrbb as. For example, if rates were to increase and a bank s deposits repriced sooner than its loans, it could result in the bank paying out more interest on deposits than the interest it is receiving from loans. Net interest income nii economic value of equity eve 2017 stress test.
Interest rate risk in banking book irrbb refers to the current or prospective risk to a banks capital and earnings arising from adverse movements in interest rates that affect banking book positions. Interest rate risk management at community banks community. Due to the heterogeneous nature of this risk, it is captured in pillar 2. Calculating interest rate risk in the banking book. If interest rates rise, the cost of funds increases more rapidly than the yield on assets, thereby reducing net income. Accepting this risk is a normal part of banking and can be an important source of pro. While interest rate risk can arise from various sources, four key types of interest rate risk are common to community bank balance sheets. This includes gap risk, which arises from the term structure of banking book instruments, basis risk, which describes the impact of. Interest rate risk in the banking book adeva partners. Introduction interest rate risk in the banking book or irrbbas defined by the basel committeeis the current or prospective risk to a bank s capital and earnings, arising from adverse movements in interest rates that affect. The interest rate risk in the banking book can be measured and controlled at present value or periodically. The standards revise the committees 2004 principles for the management and supervision of interest rate risk, which set out supervisory expectations for banks identification, measurement, monitoring and control of irrbb as well as its supervision. Interest rate risk in the banking book irrbb is the risk to earnings or value and in turn to capital arising from movements of interest rates that affect banking book positions. In april 2016, bcbs issued standards for interest rate risk in the banking book.
Measurement of banks exposure to interest rate risk author. The standards, issued for the first time in more than a decade, introduced a strengthened pillar 2 approach and set out supervisory expectations for banks identification, measurement, monitoring and control of irrbb as well as its supervision. The management of interest rate risk is therefore critical to the stability of any banking corporation. Relates only to a bank that calculates the relationship between interest rate movements or shocks and non interest income, bad debts and other relevant variables. The other two are specific to the management of interest rate risk in the banking book. Interest rate risk in the banking book irrbb bankinghub. The treatment of automatic options under the standardized approach brings. This booklet provides an overview of interest rate risk comprising repricing risk, basis risk, yield curve risk, and options risk and discusses irr management practices. Irrbb deals with the risks associated with a change in interest rates, and affecting a banks banking book, as opposed to its trading book. Whitepaper implementing interest rate risk in the banking. Interest rate increase 35 interest rate decrease 36 1. Interest rate risk in banking book masterclass bizenius. Article interest rate risk in the banking book irrbb fis. May 12, 2018 members treasury consulting llp pleased to present video titled interest rate risk in bank books irrbb.
Nevertheless, abnormal levels of interest rate risk may expose banking corporations to losses and even pose a threat to their capital. The interest rate risk in banking book refers to the risk to a banks capital and earnings arising from adverse movements in interest rates that affect banking book positions. The book is essential reading for all those involved with interest rate risk in the banking book but particularly those working in a bank alm function who wish to gain a wider appreciation of the context in which they operate, more generalist and senior bankers who need a grasp of the fundamentals and those working in a trading risk function. We do this by creating a model that reallocates the exposures to. Irrbb interest rate risk in the banking book a bearingpoint accelerator eba and the basel committee reacted to the current low interest environment with new or further detailed requirements for banks dealing with the risk arising from general banking business, known as interest rate risk in the banking book irrbb. Following consultation during 2015, bcbs published revised principles d368 in april 2016, to reflect changes in market and supervisory. Nov 11, 2016 irrbb interest rate risk in the banking book 1. Any changes in interest rates have an impact on the present value of future cash flows on the bank. The way ahead executive summary interest rate risk in banking book irrbb refers to the current or prospective risk to a banks capital and earnings arising from adverse movements in interest rates that affect banking book positions. Interest rate risk in the banking book how to manage irrbb considering the monetary policy and the new regulation. The interest rate risk booklet applies to examinations of community banks. Gap is the difference between the book value of the rate sensitive assets and the rate sensitive liabilities. The bond will still pay a 3% coupon rate, making it more valuable than new bonds paying just a 2% coupon rate.
Assessing interest rate risk in the banking book iii. We do this by creating a model that reallocates the exposures to balance sheet items. Interest rate risk in the banking book irrbb is part of the basel capital frameworks pillar 2. Uniform financial institutions rating system trading and capitalmarkets activities manual. When interest rates change, the present value and timing of future cash flows change. Interest rate risk in the banking book, written by industry expert paul newson, provides a thorough guide to the new regulatory requirements surrounding irrbb and demonstrates the importance of good governance.
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