BCBS 368 was published by the Basel Committee on April 21, 2016, a new standard for monitoring and controlling interest rate risk in the banking book (IRRBB). The standard replaces the previous BCBS 108, which had been in force since 2004 and did not contain regulations for interest rate risks in the banking book. As part of these new regulations, the European Banking Authority (EBA) published a consultation paper on the revision of its guidelines adopted in 2015 for the measurement and controlling of the interest rate risk in the banking book.
After a long, ongoing phase of low interest rates, institutions with a high degree of maturity transformation are particularly exposed to the risk of rising interest rates. Therefore, BCBS 368 should strengthen the interest rate risk in the banking book as a major type of risk (future Pillar II of the Basel pillar model) in the context of the regulatory audit and monitoring process.
Measurement & Controlling of Interest Rate Risks According to IRRBB
BCBS 368 differentiates between two metrics for the measurement and controlling of interest rate risks:
- Cash Value Perspective (EVE Approach): The focus here is on a change in the cash value of the interest-bearing assets and liabilities in the banking book if there is a change in interest rates. The cash value or market value for non-derivative products is usually determined by discounting future expected cash flows. The observation horizon is infinite so all cash flows until the end of business are taken into account. The calculation or measurement is based on a roll-off balance sheet assumption, meaning that expiring transactions are not replaced.
- Net Interest Income Approach or Earnings-at-Risk Approach: The focus here is on a change in the net interest income in the narrower sense (NII) or the greater effect on earnings such as, for example, fair value changes in the broader sense due to interest rates (earnings-at-risk (EaR)). The NII and EaR approaches examine the negative effects of a change in interest rates on the net interest income and interest-based earnings in a period. The observation horizon is between three and five years. The calculation must be made with a so-called dynamic balance sheet development, i.e. the necessity of modeling new business and “closing the balance sheet” through funding.
In addition to a definition of the interest rate risk, the standard contains, among others, principles for financial institutions to measure, control and monitor interest rate risks and principles for the supervisory authority to monitor the institution as part of the controlling and risk-bearing capacity of the interest rate risks.
Different Types of Interest Rate Risk
In terms of interest rate risks, the standard differentiates between the following forms:
- Gap Risk: Risks in connection with incongruences between the term and the interest adjustment of assets and liabilities as well as off-balance-sheet current and non-current positions (interest rate adjustment risk) or risk in the case of changes in the steepness and form of the yield curve (yield curve risk).
- Basic Risk: Risks in the hedging of an interest rate risk through a risk position that is remeasured under slightly different conditions.
- Option Risk: Risks in the options, including embedded options, such as the sale of fixed-interest products by consumers, if market interest rates change.
FAS Support for IRRBB
FAS AG will support you and your company in the analysis of your current system for measuring and controlling the interest rate risk in the banking book, in the identification of gaps as a result of the new regulatory requirements, the design of suitable adjustment measures and implementation support.
If you are interested or have any questions, please contact us.