Deadline alert: embedding the revised IRRBB framework in your next ICAAP cycle

New EBA guidelines on interest rate risk arising from non-trading book activities impact Pillar 2 financial risk

A refresher on the revised IRRBB guidelines

Interest rate risk arising from non-trading book activities (IRRBB) is a significant financial risk for credit institutions, and is considered under Pillar 2 capital requirements. The new guidelines require banks to put in place processes for identifying, managing, monitoring and controlling IRRBB.

Managing IRRBB is particularly relevant in today’s low interest rate environment, as any adverse movements in interest rates could immediately accentuate the mismatch between bank deposits and loans. This would in turn affect a bank’s net interest income, as well as the economic value of a bank’s equity as an outcome of the discounting of future cash inflows and outflows.

The revised guidelines issued by the European Banking Authority (EBA) in July 2018 take into account previous guidelines issued by the Authority in May 2015, as well as more recent supervisory expectations and practices including the standards on interest rate risk in the banking book published by the Basel Committee on Banking Supervision in April 2016.  

Four areas you should be looking into

The revised IRRBB framework establishes new expectations around banks’ processes for managing interest rate risk in the banking book, with special focus on four areas:

  • Capital requirements: IRRBB should be covered by sufficient capital, measured using regulatory guidance and internally developed scenarios that consider both earnings at risk and the impact on the economic value of equity. Furthermore, banks are now required to include credit spread risk in the banking book (CSRBB) in their methodologies.
  • Governance: the expectation is that banks develop internal policies and supporting processes governing the management of IRRBB. Models used for calculating IRRBB should be independently validated. Most importantly, a bank’s IRRBB strategy should be aligned to the institution’s overarching business objectives and risk appetite.
  • Measurement techniques: the revised guidelines provide a number of expectations around scenario development that should be embedded in IRRBB measurement techniques. These include shock scenarios on the underlying currency of exposures on a quarterly basis, negative interest rate scenarios, behavioural studies on non-maturity deposits and asymmetrical impacts on assets and liabilities.
  • Supervisory outlier test: a number of assumptions and flooring guidelines have changed from previous guidelines, including a stricter threshold for identifying outlier banks to incorporate in internal reviews. Moreover, institutions are now required to carry out and assess the impact of a minimum of six pre-defined shock scenarios on their own funds, including two parallel shocks, steepener and flattener shocks, and short rates shocks. Supervisors may implement additional tests and publish criteria around identification of outlier banks.

Your next ICAAP

Ultimately, the revised IRRBB guidelines are driven by the growing impact of interest rate risk on profitability and will have a significant impact on banks’ ICAAP process. The new guidelines push banks to integrate or further align IRRBB into their strategic objectives and risk appetite framework before the next regulatory submission.

How can Deloitte help?

DBAR reporting tool

Our proprietary financial risk management tool allows you to create synergies between your regulatory reports, ensuring full alignment between capital and liquidity assessments and strategic decision-making.

IRRBB gap analysis

Current state assessment of your alignment with the revised IRRBB guidelines, including a review of your internal governance and modelling approach.

Bespoke training and seminars

Bespoke training and seminars. Provision of training by Deloitte specialists, including Board and executive training and differentiated learning modules for risk managers and officers.

Drafting of policies and procedures

Assistance in the drafting of the full suite of policies and procedures using our in-house checklist tailored to your business.

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