Houpt, of the boards division of banking supervision and regulation, prepared this article. Sources of irrbb include interest rate gaps, basis risk, yield curve risk and option risk. Interest rate risk in the banking book interest rate risk in the banking book irrbb can be a significant risk for banking institutions and new regulations will have a significant impact on their risk management frameworks. This began in june 2004 when the basel committee on banking. 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.
Guidelines set the eba view of appropriate supervisory practices within. Interest rate risk in the banking book irrbb due to different fixed interest rates of assets and liabilities allocated to the banking book, credit institutions are exposed to a risk of changing interest rates on the money and capital markets. While interest rate risk can arise from various sources, four key types of interest rate risk are common to community bank balance sheets. Guidelines on the management of interest rate risk arising. 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. The basel committee for banking supervision bcbs published the final standards on interest rate risk in the banking book irrbb on april 21, 2016. Irr in the trading book is subject to pillar i and hence carries a capital charge, whereas interest rate risk in the banking book irrbb is subject to pillar 2 and does not carry a regulatory charge.
Changes in interest rate affect earnings, value of assets, liability, offbalance sheet items and cash flow. Bpfi has submitted a response to the european banking authoritys eba consultation paper on the draft guidelines on the management of interest rate risk arising from nontrading book activities. Compliance with the basel committees standards on interest rate risk in the banking book bcbs 368 and eba final report july 2018 on interest rate risk in the banking book irrbb presents significant challenges to all banks with respect to measurement, calculation, reporting and hedging of interest rate risk, as well as potential implications for pillar 2a capital requirement, and this. 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. There are new rules for an appropriate assessment of the interest rate risk of new products in the banking book e.
In may 2015, the european banking authority eba published an update to the guidelines for managing interest rate risk in the banking book irrbb. Publications and research research papers interest rate risk in the banking b. Interest rate risk in the banking book risk library. The european banking authority eba has issued an update of its interest rate risk in the banking book irrbb guidelines as a first step in the implementation of the updated basel committee on banking supervision bcbs standards adopted in april 2016. Final bcbs standards on interest rate risk in the banking. Managing interest rate risk in the banking book actively manage interest rate risk, improve frameworks and advance behavioural models under the eba s final irrbb guidelines to steer banks into the optimal position learn from key practical case studies mbank explore correct modelling of nonmaturing deposits and prepayment deposits for irrbb. The fair market values of a bank s assets and liabilities are directly linked to. For the ebf position paper on interest rate risk in the banking book, please consult the following link. If a bank does an interest rate swap with a customer, thats trading book. Guidelines on technical aspects of the management of interest. This publication can be found online on the ebf website and is subject to regular updates. Implementing interest rate risk in the banking book irrbb. Nov 11, 2016 irrbb interest rate risk in the banking book 1. The impact of interest rate risktaking on a banks profitability.
The management of interestrate risk in the banking book irrbb has been. This includes gap risk, which arises from the term structure of banking book instruments, basis risk, which describes the impact of. What is interest rate risk in the banking book irrbb. 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. In mid2019, the new guidelines will replace the previous eba irrbb guideline published in 2015. This paper looks at the standards from a practical implementation point of view and raises some of the main challenges. Uniform financial institutions rating system trading and capital markets activities manual. The corresponding circular from 2011 will be repealed circular 112011. Interest rate risk in banking book irrbb refers to the current or prospective risk to a bank s capital and earnings, arising from adverse movements in interest rates that affect banking book positions. Any changes in interest rates have an impact on the present value of future cash flows on the bank.
Guidelines on technical aspects of the management of interest rate. 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. Irrbb refers to the current or prospective risk to the banks capital and earnings arising from adverse movements in interest rates that affect the banks banking book positions. The interest rate risk in banking book refers to the risk to a bank s capital and earnings arising from adverse movements in interest rates that affect banking book positions. The eba has issued an update of its interest rate risk in the banking book irrbb guidelines as a first step in the implementation of the. This white paper focuses on understanding how current market conditions low interest rates can affect banks revenues and profitability. Interest rate risk on the banking book springerlink. Interest rate risk in the banking book irrbb bankinghub. 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. 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. The new basel committee on banking supervision bcbs standards for irrbb come into force january 1, 2018. Meeting the practical challenges highlights the new basel committee on banking supervision bcbs standards for irrbb come into force january 1, 2018.
Eba technical guideline on interest rate risk in the. If passages have been quoted from the original, credits have been given. Bafin issues circular on rules for interest rate risk in. These standards are intended to replace an earlier guidance set out in the 2004 principles for the management and supervision of interest rate risk 4, which laid out the principles and the methods expected to be used by banks for measuring, managing, monitoring and. The european banking authority eba should not front run the european process. The analytical var for interest rate risk in the banking book can be calculated as follows. In april 2016, the basel committee on banking supervision issued its final standards for irrbb interest rate risk in the banking book. Nii, on the other hand, is always based on cash flows at client rates and thus represents total nii. A bank may use this measure to create models that indicate how interest rate changes will affect its total capital. 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. 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. The remaining part will be implemented through the ongoing revision of the capital requirements directive. Calculating interest rate risk in the banking book. Interest rate risk in the banking book objective and key requirements of this prudential standard this prudential standard sets out the requirements that an authorised deposittaking institution must meet in relation to interest rate risk in the banking book.
Banks earn returns to shareholders by accepting and managing risk, including the risk that borrowers may. Interest rate risk in the banking book banking and. Standards for interest rate risk in the banking book issued. Leeto tlou and jonathan hacker provided assistance. 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. A financial institutions banking book is composed of all assets that are not actively. Whitepaper interest rate risk in the banking book irrbb. Enhanced requirements for irrbb management insights from ey european irrbb survey 2016 for banks 1 historically, interest rate risk in the banking book irrbb has been a risk to which many in the market have paid less attention compared to liquidity risk and credit risk. On 19 july 2018, the european banking authority eba published the new guideline on the management of interest rate risks in the banking book irrbb. 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. This is known as interest rate risk in the banking book or irbb. Interest rate risk in the banking book irrbb definition.
Why is ecb banking supervision conducting the ecb sensitivity analysis of interest rate risk in the banking book irrbb stress test 2017. Such unconventional monetary policy has an impact on interest rates, and therefore, requires a closer monitoring of the interest rate risk in the banking book irrbb. Scenarios once the scope of the interest rate risk method has been determined, then consideration can be given to the scenarios with interest rate shocks that will be used in the. The forthcoming capital requirements directive crd 5 and capital requirements regulation crr 2 implement the bcbs standards in the regulatory framework of the european union. Deutsche bank annual report 2017 nontrading market risk. It is aimed at german institutions and contains revised guidelines for calculating the effects of a sudden and unexpected interest rate change basel default shock. 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. 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. Investors need to know which ones will best serve their needs in todays dynamic bond market. Feb 11, 2017 draft guidelines on governance, measurement, and management of interest rate risk in banking book statement on development and regulatory policies by rbi dated october 4, 2016 available from website. The eba guidelines on the management of interest rate risk arising from nontrading activities have been developed in accordance with article 16 of regulation eu no 10932010 and article 985 of directive 2036eu. Sep 08, 2010 interest rate risk in banking is the potential negative impact on the net interest income and it refers to the vulnerability of an institutions financial condition to the movement in interest rates.
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. The interest rate risk in the banking book can be measured and controlled at present value or periodically. When interest rates change, the present value and timing of future cash flows change. Eba publishes final guidelines on interest rate risk in the banking book. European banking industry common understanding of credit. 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. The risk that assets and liabilities reprice or mature at different times, causing margins between interest income and interest expense to narrow. The new standards will apply from january 2018 onwards but some supervisors have already given a lot of attention to how irrbb is monitored and managed at many banks, given the current concerns about the lingering low interest rate environment. These standards replace the principles for the management and supervision of interest rate risk from july 2004 and build up on the consultation phase. 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.
Ebagl201802 on the management of interest rate risks. 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. Guidelines on the management of interest rate risk arising from. Excessive irrbb can pose a significant threat to a bank s current capital base andor future earnings if not managed appropriately. 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 in 2015, two documents were published that will have a significant impact on the risk management framework of banking institutions. An analysis of commercial bank exposure to interest rate risk david m. Compliance with the basel committees standards on interest rate risk in the banking book bcbs 368 presents significant challenges to all banks with respect to measurement, calculation and hedging of interest rate risk, and this whole area is the subject of intense focus from the regulatory authorities. It is important to note the advantage of using independent principal components. Ecb sensitivity analysis of irrbb stress test 2017. Whitepaper implementing interest rate risk in the banking.
Interest rate risk in the banking book banking and payments. Executive summary the european banking authority eba has updated the cebs guidelines on technical aspects of. Interest rate risk in banking book irrbb refers to the current or prospective risk to a bank s capital and earnings arising from adverse movements in interest rates that affect banking book positions. 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 requirements directive directive. Ebagl201802 on the management of interest rate risks kpmg. We do this by creating a model that reallocates the exposures to balance sheet items. Accordingly, effective risk management that maintains interest rate risks at prudent levels is essential to the safety and soundness of banking institutions. Andreas dombret, member of board, deutsche bundesbank in.
Interest rate risk in the banking book marcus evans. Its aim is to identify earnings volatility over a 12monthhorizon against the two instantaneous parallel shock scenarios. Standards on the interest risk in the banking book irrbb. The revised guidelines replace the existing guidelines and will be applicable from 01 january 2019. How bcbs 368 will affect alm 3 distinction is useful from a management and treasury perspective too see below. Interest rate risk is an integral part of banking business, and may even be a source of profit. Interest rate risk in the banking book irrbb, to take effect from 31 december 2017, sets out pillar 2 requirements for the identification, measurement, monitoring and control of irrbb, and disclosure requirements under prescribed interest rate shock scenarios.
What is the difference between a banking book and a. Final report on revised guidelines on the management of interest rate risk arising from nontrading activities ebagl201802 compliance table. Department of banking regulation reserve bank of india, central office mumbai 400 001. Appropriate capital allocation for irrbb in the future needs to consider inter est rate risk from portfolios evaluated at fair value through other. Interest rate risk in the banking book advanced adis this prudential standard sets out the requirements that an authorised deposittaking institution with approval to use an internal model for interest rate risk in the banking book must meet for regulatory capital purposes, both at the time of initial implementation. The basel committee on banking supervision has today issued standards for interest rate risk in the banking book irrbb. 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. Jul 20, 2016 on the 3rd of june 2016, marcus evans held a webinar entitled interest rate risk in the banking book in partnership with oracle for their global financial market webinars portfolio. Due to different fixed interest rates of assets and liabilities allocated to the banking book, credit institutions are exposed to a risk of changing interest rates on the money and capital markets. Interest rate risk in the banking book zanders treasury. Irrbb includes potentially adverse effects on earnings, capital, or both. Interest rate risk in the banking book contents irrbb ebf. In april 2016, the basel committee on banking supervision bcbs published the standards on interest rate risk in the banking book irrbb. For the section on the internal capital allocation for irrbb, the existing.
Interest rate risk in the banking book is too dependent on the specific characteristics of institutions to enable a formalized capital requirement. 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. 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 is part of the basel capital frameworks pillar 2. Guidelines on technical aspects of the management of. Interest rate risk in the banking book irrbb banking and. To create more consistency across the board and get banks in a position where they can face challenging situations relating to interest rate risk, the eba have been developing irrbb guidelines, where following a consultation period taking place at the moment, the eba final guidelines will be upon us soon. Implementing interest rate risk in the banking book irrbb polling results in march 2017, moodys analytics, together with asia risk and, held a webinar, interest rate risk in the banking book. The precise answer is both complex and involves considerable latitude for opinion. This book reveals how more than three dozen experts control and preserve the value of their own fixed income portfoliosfrom choosing the right risk management product to monitoring and evaluating the effectiveness of hedge management strategies. Risk in the banking book csrbb defined by the european banking authority eba guidelines on the management of interest rate risk arising from nontrading book activities context in april 2016, the basel committee on banking supervision bcbs published the standards on interest rate risk in the banking book1 irrbb. The bafin issued a new circular circular 918 on the interest rate risk in the banking book irrbb.
Bcbs proposals for interest rate risk in the banking book irrbb. Interest rate risk management at community banks community. Interest rate risk on the banking book irrbb is defined as the current or perspective risk to the bank s capital and earnings arising from adverse movements in the interest rates that affect the institutions banking book positions bcbs, 2015. An analysis of commercial bank exposure to interest rate risk. The management of interest rate risk is therefore critical to the stability of any banking corporation. Interestrate risk in the banking book irrbb regtech. 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. Irrbb deals with the risks associated with a change in interest rates, and affecting a banks banking book, as opposed to its trading book. Nevertheless, abnormal levels of interest rate risk may expose banking corporations to losses and even pose a threat to their capital.
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