Interest rate risk in the non-trading book: approaching the target regulatory framework - Deloitte
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Interest Rate Risk in the Banking Book Interest rate risk in the non-trading book: approaching the target regulatory framework Banks’ readiness for main regulatory news Introduction The review of the Pillar 2 Framework under Basel IV has progressively emphasized the importance of the IRRBB management for European credit institutions. Accordingly, the CRD 5 and CRR 2 published on June 2019 complete the process of transposition of the BCBS international standards providing details on the management of interest rate risk arising from non-trading activities. In that framework, the CRD 5 mandates to the EBA to develop Regulatory Technical Standards and revised Guidelines on IRRBB which, originally expected to be released and adopted within June 2021, have been now postponed to March 2022 due to the current pandemic emergency and the huge workload the EBA is facing. Nevertheless, in order to be prepared for facing the current uncertainty with a reactive and sound framework while also ensuring a prompt adoption of the forthcoming regulatory prescriptions, Banks should exploit this time to verify the proper and full application of the current regulatory framework (i.e. 2018 EBA GLs on IRRBB) also assessing the coherence and the integration of the IRRBB framework with other risks (e.g. PD models and Funding strategies). Moreover, in light of impacts of Covid-19 over customers’ behavior, the monitoring of deposit flows should be reinforced for quickly assess any needs of recalibrating current behavioral models and for ensuring the reliability of IRRBB metrics and outstanding hedging strategies. 01
Interest Rate Risk in the Banking Book
Regulatory controlling the IRRBB as well as giving
guidance for the conduction of the
updates Supervisory Outlier Test as a supervisory tool
Interest Rate Risk in the Banking Book (IRRBB), for monitoring and comparing banks’
intended as the risk to both earnings and exposures on IRRBB.
economic value (and in turn to capital) of an
The second step is represented by the entry
institution arising from impacts of adverse
into force of the revised Regulatory Risk
movements in interest rates on sensitive
Package CRD 54 and CRR 25 that will complete
positions on banking book, is nowadays
the process of transposition of the legislation,
receiving increasing attention from the market
in accordance with the BCBS international
EBA: “Institutions players mainly due to:
standards, and provide a revised IRRBB
• The outbreak of the pandemic emergency
should treat IRRBB which affected retail and wholesale
Framework.
as an important risk customer behaviour and, in turn, stressed
Accordingly, in line with the CRD6 and as
reported within the “EBA Risk Reduction
and always assess it deposits flows potentially invalidating
behavioural model outcomes.
Package Roadmaps”7, the EBA is mandated to
explicitly and • Responses to rate changes from the current
develop regulatory technical standards (RTS)
and to update the EBA Guidelines that will
comprehensively in low or negative levels which could diverge in
provide institutions with details about new
terms of both monetary policies and
their risk customer behaviour thus creating
regulatory requirements. Nevertheless, the
original deadline of June 2021 is postponed8 to
management uncertainty for the banking sector.
March 2022 mostly due to the workload the
processes and • The international regulatory framework
since has been enriched with Standards for
EBA is facing in addressing both mandates
from the Risk Reduction Package as well as the
internal capital IRRBB issued by the Basel Committee on pandemic emergency.
assessment Banking Supervision (BCBS) in 2016 and
which adoption is still in progress.
The amendments include the introduction of a
processes.” In light of the above, the management of
common standardised approach, the
requirement to monitor and assess CSRBB
IRRBB has acquired relevance within financial and the addition of the NII perspective to
risks for European credit institutions guided by complement the EVE for the interest rate risk
the regulatory evolution, which has passed in management and the supervisory outlier test.
Europe through a multi-phased approach in
More in detail, main regulatory news are:
converging toward IRRBB Standards defined
• The introduction of a common standardised
by BCBS for the review of the Pillar 2
approach and a simplified standardised
Framework under Basel IV.
methodology (for small and non-complex
The first step towards the implementation of institutions) that institutions may use for the
IRRBB Standards1, aimed to bridge the gap IRRBB management as well as the related
before the issuance of the revised Risk conditions of applicability.
Reduction Package, is represented by the
• The definition of criteria for determining
“EBA Guidelines on the management of interest
whether or not the implemented internal
rate risk in the non-trading book”2, implemented
systems are satisfied.
from July 2019 and amending those issued in
20153. The guidelines introduce an approach
for identifying, measuring, monitoring and
1 BCBS, Standards Interest rate risk in the banking 4 Directive (EU) 2019/878 of the European 7 EBA, Risk Reduction Package Roadmaps, EBA
book, April 2016. Parliament and of The Council Of 20 May 2019 and Tasks arising from CRD 5 – CRR 2 – BRRD 2,
2 EBA, Guidelines on the management of interest it will mostly apply on 29 December 2020. November 2019.
5 8
rate risk in the non-trading book (EBA/GL/2018/02), Regulation (EU) 2019/876 amending Regulation EBA, correspondence related to “technical
July 2018. (EU) No 575/2013 and will apply from 28 June 2021 standards for the risk reduction measures package”
3 EBA, Guidelines on the management of interest onwards. June 2020.
rate risk in the non-trading book (EBA/GL/2015/08), 6 Article 98(5a), Article 84(5), Article 84(6)
May 2015.
02
Interest Rate Risk in the Banking Book
• The monitoring and assessment of credit • Coherence of methods and methodologies evolution for micro-cluster of clients (e.g. via
spread risk from non-trading book activities for the IRRBB management and the Machine Learning clustering techniques on
(CSRBB). calculation of the economic capital for ALM models outcomes). In turn, such
• The performance of the supervisory outlier ICAAP purposes. approach would increase the predictability
test (SOT) on IRRBB under both the NII and • Integration and coherence of IRRBB models power of the Credit Risk models considering
EVE perspectives (currently applicable only and methodologies with other risks (e.g. the relevance of realized and expected
on EVE) and the definition of what Liquidity, Credit risks). customers’ cash accounts information for
constitutes a large decline under NII estimating PDs.
• Adequacy standards for the IT and Data
(namely, in terms of thresholds definition). Quality systems. • Exploiting the modelling of sight items for
identifying stable sources of funding for
Update of behavioural models framework liquidity risk purposes as well as for defining
Main Actions In line with the EBA Guidelines and in order to and refining hedging strategies and related
address the Covid-19 impacts (refer to Focus replicating portfolios.
In this context, it is fundamental for
institutions to take advantage of this period on Covid-19), institutions should update their
behavioural models’ framework in order to Implementation of IRRBB scenario analysis
before the issuance of the new regulatory
framework to verify their compliance with the improve their predictability as well as granting and stress testing
EBA Guidelines on IRRBB through a self- the monitoring of the performance via back- The estimation of the IRRBB exposure should
assessment analysis as a preliminary step testing exercises, the quantification of the follow a “scenario” approach, namely
toward the adoption of the revised IRRBB model risk for ICAAP purposes and the estimating the sensitivity of risk exposure with
regulatory framework in line with the periodic analysis of materiality of balance respect to macro-financial assumptions.
proportionality principle. sheet items relevant for modelling (e.g. sight However, this would not limit the scope of the
items). Moreover, in line with the market best analysis to the current and upcoming
In particular, institutions should take into regulatory exercises but shall be extended to
practice and in order to obtain more reactive
account the implementation of the following managerial purposes, reinforcing the bank
computations supporting the managerial
pillars: profitability through specific balance sheet
decisional process during the pandemic
emergency, the Bank should evolve the government processes and strategic planning.
Governance Therefore, impacts on economic value and
underlying methodology introducing new
A sound and integrated Governance for the earnings have to be calculated also under
estimation techniques (e.g. machine learning)
IRRBB would ensure the management of the additional managerial scenarios tailored to the
also in order to exploit the modelling
risk coherently with the overall banking bank’s peculiarities and defined taking into
outcomes for fostering the integration among
strategy and in accordance with the risk target account:
various risks, such as:
and risk appetite. Accordingly, the IRRBB
• Adopting the ALM sight deposit models’ • Different underlying assumptions in terms of
Policy shall define roles and responsibilities in
outcomes within the Credit Risk Probability stress/shift on the balance sheet (e.g. run-
compliance with regulatory prescription while
of Default and scoring models. This would off, constant, dynamic assumptions), the
ensuring the:
allow integrating the credit models with a yield curve (e.g. parallel, non-parallel),
• Integration of the IRRBB measures in the
forward-looking module on cash accounts
definition of the overall strategy.
• Definition of the Risk Appetite Framework
for IRRBB in terms of triggers and limits for Focus on impacts of Covid-19 emergency to customers’ behavior
both EVE, NII and, if material, also for each The pandemic emergency has hugely affected the macro-economic outlook and, in turn, influenced retail and
sub-type of risk (i.e. Gap Risk, Basis Risk and wholesale customers since have shifted toward a more prudent behavior to face the period of uncertainty.
Option Risk). The generated inflows attenuated net outflows driven by an increase in drawings of credit lines and market
tensions: overall Banks’ liquidity positions did not show any deterioration in Q1 2020 (namely, LCR remained
• Definition of criteria for the internal roughly stable) according to the EBA Risk Dashboard (published as of 30th of July 2020). Nevertheless, during
assessment of the adequacy of the IRRBB following months (when most government supports will conclude) banks may experience increasing level of
Framework. distressed customers and, consequently, higher exposure towards interest rate risks on deposits.
• Proper development and validation of the In light of the above, banks are planning specific actions such as revisiting behavioral models on sight items,
IRRBB measurement including behavioural reassessing current underlying assumptions, rebalancing replicating portfolios and refining stress scenarios in
order to mitigate arising risks among which inaccurate hedges or misleading of IRRBB metrics. Moreover, a
models, the treatment of the related model
strict monitoring of deposit flows and the related deviations of observations respect to predictions is required
risk, the CSRBB and the Stress Test analysis.
for promptly evaluating any needs of model recalibration.
03Interest Rate Risk in the Banking Book
behavioural models and commercial
margins.
• The opinions of experts from involved
How can Deloitte
functions ensuring consistency with business help?
strategy. Deloitte’s risk management team leverages on
• The macroeconomic environment (e.g. the market intelligence and industry expertise
current economic conditions driven by the when assisting you in implementing a sound
pandemic emergency shall be reflected in Risk Framework. This would be crucial for
defining an ad-hoc scenario). facing the management of the IRRBB during
• The interaction with other related risk the current challenging environment while
categories, such as credit risk and liquidity reducing the normative gap against the
risk. upcoming regulatory reform. Accordingly, in
line with the current and upcoming regulatory
The shock sizes and scenarios should be
prescriptions, Deloitte relies hands on
reviewed and recalibrated periodically.
experience in supporting you to:
Development of IRRBB hedging strategies • Perform a gap analysis of the whole IRRBB
With reference to IRRBB hedging strategies, it framework to promptly ensure full
is particularly relevant for Banks understating compliance toward current regulation in
benefits deriving from their definition and order to foster the bank in adopting the
implementation. imminent extended regulatory framework.
Consequently, due to the complexity in the
• Supporting the identification and resolution EBA: “Institutions
implementation of an adequate natural
of any deficiency which may impede a sound
and a reactive management of the risk
should identify their
hedging framework, institutions should adopt
tailored hedging strategies in order to reduce
during the Covid-19 emergency. existing and
the effects of changes in interest and income • Define and implement an integrated IRRBB prospective
exposure to IRRBB
statements. Besides, the current low costs Governance covering all crucial aspects
associated with hedging strategies are emphasized by regulators.
definitively representing a unique chance to • Define, develop and implement a in a proportionate
grasp. On the other hand, the drastic
reduction of earnings volatility ensured by
methodology for the measurement of
IRRBB.
manner, depending
carrying out a thorough hedge accounting • Design IRRBB scenario analysis and stress on the level,
framework would be beneficial for several tests methodologies in line with regulatory complexity and
reasons, such as:
riskiness of the non-
and market best practices also with the aim
• A reduction of the internal capital allocated of supporting managerial actions.
to hedge against market fluctuations. • Review and validate behavioural models’ trading book
• The improvement of short and long-term framework through the use of new
positions they face,
estimation techniques able to exploit the
liquidity profile thanks to constant cash flow.
modelling outcomes for fostering the or an increasing risk
• A lower level of idiosyncratic risk financial
institutions may face, with benefit in terms
integration among various risks (e.g. Credit profile taking into
and Liquidity Risk).
of equity risk premium.
• Development of IRRBB hedging strategies in
account their
The arrangement of accurate hedging order to grant steady annual results and business model,
strategies and their translation in a suitable
accounting framework would, therefore, grant
ensure a better investor’s perspective of the
institution’s soundness.
their strategies and
steady annual results and ensure a better
• Define and implement reporting and the business
investor’s perspective of institutions’ financial
soundness.
monitoring processes. environment they
operate in or intend
to operate in.”
04Interest Rate Risk in the Banking Book Contact us: Francesco Zeigner Elisabetta Tisato Partner Director Tel: +39 02 83323464 Tel: +39 02 83323597 Mobile: +39 335 7376947 Mobile: +39 348 8863012 Email: fzeigner@deloitte.it Email: etisato@deloitte.it Pasquale Coviello Fabio D’Andrea Manager Manager Tel: +39 02 83327196 Tel: +39 02 83322611 Mobile: +39 345 6156007 Mobile: +39 333 4619781 Email: pcoviello@deloitte.it Email: fadandrea@deloitte.it Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), its global network of member firms, and their related entities (collectively, the “Deloitte organization”). DTTL (also referred to as “Deloitte Global”) and each of its member firms and related entities are legally separate and independent entities, which cannot obligate or bind each other in respect of third parties. DTTL and each DTTL member firm and related entity is liable only for its own acts and omissions, and not those of each other. DTTL does not provide services to clients. Please see www.deloitte.com/about to learn more. © 2020 Deloitte Risk Advisory S.r.l.
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