The Basel Committee on Banking Supervision (BCBS) published finalised revisions to the standards for assessment of Interest Rate Risk in the Banking Book (IRRBB) on 21 April 2016.
Following its 2015 consultation on IRRBB the Basel Committee has decided to leave IRRBB within the Pillar 2 framework. There had been a suggestion that it be brought into Pillar 1 but this was met with strong opposition from the industry. Instead, Basel has decided to expand its existing IRRBB guidance for Pillar 2 to take account of market developments in recent years. A more methodical approach to IRRBB assessment will be required. This is a further example of the ongoing development of Pillar 2 into a more prescriptive set of risk assessments that resemble the Pillar 1 approach.
The new Standardised Framework for assessment of IRRBB includes prescribed interest rate shock scenarios which banks must use to assess the sensitivity of their assets and income to interest rate shifts. In addition to the prescribed scenarios, banks must develop their own shock and stress scenarios for assessing their exposure to IRRBB. With the permission of their regulator banks can use an internal model to measure IRRBB instead of the Standardised Framework, but these models will be subject to a strict internal validation process.
Banks will need to disclose details of their exposure to IRRBB in a prescribed table. These disclosures will detail the potential impact that a prescribed interest rate shock scenarios would have on the economic value of equity and net interest income.
Regulators must identify 'outlier banks' - i.e. banks that would experience a depletion of 15% of Tier 1 capital as a result of the prescribed shock scenarios set out in these revised standards. Further supervisory action will be required where a review of a bank's IRRBB exposure reveals inadequate management or excessive risk relative to a bank's capital, earnings or general risk profile.
In the UK the PRA already assesses banks' exposure to IRRBB under Pillar 2. Last year the PRA disclosed the IRRBB methodology that it assesses banks against. This focuses on basis risk (risk of rates changing), duration risk (where re-pricing of products is mismatched across time buckets) and optionality risk (such as the risk of early repayment of interest-bearing loans). As a result, these newly released standards from Basel will not be an entirely new process for UK banks to follow. However, banks will need to familiarise themselves with those elements of the Basel standards that differ from the existing PRA methodology, e.g. disclosure of IRRBB and internal development of shock and stress scenarios.
The revised standards are due to be implemented by 2018. In keeping with the scope of the Basel framework, they are aimed at large internationally active banks. National supervisors can extend their application to smaller banks if they wish. The experience in Europe suggests that European policymakers and regulators will do just that. Attention will now shift to European regulatory authorities such as the European Commission as the industry watches closely to see how these standards will be incorporated into European regulation.
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