Implementation of the final EBA Guidelines on IRRBB and CSRBB

We have split this article in two sections:

• Key takeaways for banks to ensure a sound IRRBB and CSRBB framework;
• Main regulatory changes¹, covering the:
  • Updated Guidelines on CSRBB and IRRBB;
  • RTS on the standardised approach (SA) for IRRBB measurement; and
  • RTS on the supervisory outlier test (SOT)².

Key takeaways for banks to ensure a sound IRRBB and CSRBB framework

We expect that the implementation and application of the updated Guidelines and RTS will be one of the larger regulatory deliverables for banks’ ALM risk departments over the period to come. We advise banks to take action and define next steps to overcome their challenges and reach timely implementation. In general, we recommend banks to reassess their entire IRRBB and CSRBB management and measurement framework based on the recent publication, with particular focus on the following aspects:

• Create a consistent definition of CSRBB and integrate this in internal policies and frameworks to initiate risk identification and materiality assessments. This requires banks to analyse the credit spread sensitivity of their banking book instruments to define the scope of CSRBB and consequently develop and implement CSRBB models.
  
• Implement the five-year cap on the behavioural repricing maturity of certain non-maturing deposits (NMDs). This requires banks to update their tooling and systems and assess the expected impact from this cap and the potential consequences this has for hedging practices.
  
• Assess whether the updated criteria to identify a non-satisfactory IRRBB internal measurement system (IMS) may lead to the mandatory application of the SA, this could especially be challenging for banks with an IMS that is fundamentally different from the SA.
  
• Assess the economic value of equity (EVE) SOT outcome against the new threshold (15% of Tier 1 capital). Consequently, banks should reassess their risk appetite in relation to the new threshold and/or implement mitigating steering mechanisms.
  
• Implement the net interest income (NII) SOT in the bank’s model landscape and reporting process. Banks are especially challenged to think about consistency in their IRRBB framework (e.g. between internal and regulatory metrics), identify key drivers that might result in an NII impact, as well as to identify potential steering mechanisms.
  

Main regulatory changes

Updated Guidelines on IRRBB and CSRBB
Identification, management and measurement of IRBBB

The updated Guidelines are primarily based on EBA’s 2018 Guidelines on the identification, management and measurement of IRRBB under internal systems. There are, however, two important aspects that have changed.

Firstly, in IRRBB measurement, banks should apply a five-year cap on the behavioural repricing maturity of certain NMDs³. Dependent on the (modelled) stickiness of banks’ NMD portfolios, this change could impact a bank’s measurement (e.g. value sensitivity) and management (e.g. hedging) perspective. In its recent press release, the EBA announced that it will closely scrutinise the application and effect of this cap.

Secondly, the criteria to identify whether an IMS is non-satisfactory are updated. In particular, two generic criteria are specified in the updated Guidelines:

• An IMS should cover all material components of interest rate risk (gap risk, basis risk and option risk), and measures should capture all material dimensions of risk for significant assets, liabilities and off-balance sheet instruments;
• An IMS should be calibrated, back-tested and reviewed on an appropriate frequency and should be supported by a due governance and documentation.

In case competent authorities identify an IMS as non-satisfactory, they could require a bank to apply the SA for banks.

Assessment and monitoring of CSRBB

The assessment and monitoring of CSRBB is described extensively in the updated Guidelines, whereas it was only briefly mentioned in previous publications. We expect that the increased attention and guidance on this topic will provide one of the larger challenges for banks’ ALM risk departments over the coming years. Key topics for banks on the assessment and monitoring of CSRBB are related to:

• Definition: The EBA defines CSRBB as the risk arising from changes to the market credit spread and market liquidity spread for a given credit quality, as is illustrated in Figure 2 (showing a breakdown of the client rate a bank pays or earns on its products). These spreads are defined as follows:
  • The market credit spread represents the credit premium required by market participants for a given credit quality, where the changes to the market credit spread due to a rating migration are not in scope of CSRBB; and
  • The market liquidity spread represents the liquidity premium that sparks market appetite for investments and presence of willing buyers and sellers.

• Scope: The EBA states that all banking book products should be considered in the scope of CSRBB, where products should be excluded in case of proven absence of sensitivity to credit spread risk. And, in any case, banks must include assets accounted at fair value in the scope of CSRBB.
  
• Measurement: Banks should develop and use their own methodologies for the assessment and monitoring of CSRBB, which should be adequate for the complexity of the bank itself. In line with IRRBB, banks should measure CSRBB both under economic value and net interest income plus market value changes perspectives.

RTS on the SA for IRRBB

Banks may be allowed (or required, in case of non-satisfactory IMS) to use the SA for IRRBB to calculate the impact of potential interest rate movements on both EVE and NII⁴. The SA for EVE closely resembles the methodology described in the standards on IRRBB published by the Basel Committee on Banking Supervision (BCBS) in 2016⁵, whereas the SA for NII is newly introduced in this RTS.

The SA for EVE and NII can be broken down into five generic calculation stages (see Figure 3)⁶:

1. Categorising interest rate sensitive banking book products based on their amenability to standardisation;
2. Slotting of notional repricing cash flows into 19 predefined time buckets;
3. Determining ∆EVE and ∆NII using the slotted notional repricing cash flows for each currency and interest rate shock scenarios;
4. Computing add-ons for automatic options and basis risk (the latter only for NII);
5. Computing total ∆EVE and ∆NII as maximum of the worst aggregated reduction in respectively EVE and NII across the defined interest rate shock scenarios. 

RTS on the SOT

The purpose of the SOT is to assess banks’ IRRBB vulnerabilities under a set of prescribed interest rate shock scenarios by measuring (and periodically reporting) the impact on EVE and NII under these scenarios⁷​. In particular, banks that breach the impact thresholds (defined in the RTS on the SOT) may face supervisory measures such as: i) additional own funds requirements, ii) limitations on activities with excessive risks, or iii) prescribed modelling and parametric assumptions in the measurement of IRRBB.

The most notable changes coming from the RTS are:

• A change in the threshold of the EVE SOT from 20% of Tier 1 + Tier 2 capital to 15% of Tier 1 capital.
• A change to the floor to be applied on post-shocked interest rates for the EVE SOT, affecting the discount rates for downwards shock scenarios. In particular, the new floor starts at -150 bps for immediate maturity and gradually increases with 3 bps per year.
• The introduction of the NII SOT as the additional calculation that banks should integrate in their model landscape and regulatory reporting processes. Here NII is defined as interest income minus interest expense, and thus the changes in the market value of fair value instruments are not included. The metric and threshold against which the NII impact is assessed is defined as⁸:

NII_shock - NII_baseline
                ___________________     > -2.5 %
Tier 1 capital

Other key policy choices and assumptions with respect to the NII SOT are:

• Inclusion of commercial margins and other spread components in the projection;
• A constant balance sheet, i.e. reinvesting in instruments with comparable features​;
• A one-year projection horizon.

Interested in discussing this further?

Given recent macro-economic developments, e.g. increasing interest rates, increasing inflation and decreasing consumer confidence, sound measurement and management of banks’ exposures to interest rate – and credit spread movements becomes extra relevant. Over the coming period, the EBA will closely monitor the implementation of the updated Guidelines and RTSs¹. Our team of Market Risk and ALM specialists from Deloitte understands the challenges banks are facing with regard to the implementation of the updated Guidelines and RTSs, and is keen to have a discussion.

¹ Source: https://www.eba.europa.eu/eba-publishes-final-standards-and-guidelines-interest-rate-risk-arising-non-trading-book-activities
² The Guidelines will apply from 30 June 2023, except for the part on CSRBB, which will apply from 31 December 2023. The RTS on the SA and the RTS on the SOT will enter into force on the twentieth day after publication in the Official Journal of the European Union.
³ See for more details article 111 of the updated Guidelines. Note that in the 2018 Guidelines the five-year cap is only applicable in the SOT, the updated Guidelines prescribe to additionally apply the cap as part of internal IRRBB measurement.
⁴ Furthermore, a simplified standardised approach (S-SA) is developed to be used for small and non-complex institutions, the S-SA has various simplifications compared to the SA and is at least as conservative.
⁵ Source: https://www.bis.org/bcbs/publ/d368.htm
⁶ See for additional details the RTS on the SA: https://www.eba.europa.eu/regulation-and-policy/supervisory-review-and-evaluation-process-srep-and-pillar-2/regulatory-technical-standards-irrbb-standardised-approach
⁷ For the EVE SOT, banks should calculate and report the EVE impact under six interest rate shock scenarios prescribed in the RTS on the SOT (following the methodology described in the standards on IRRBB by the BCBS). And for the NII SOT, banks should calculate and report the NII impact under two prescribed interest rate shock scenarios. 
⁸ The EBA published an Opinion in response to the EU Commission’s amendments relating to the draft RTS on the SOT on April 26th. As part of this Opinion, the EBA suggests amendments to its initial draft RTS. Specifically, the EBA proposes to amend the level of the threshold, i.e. replacing the original level of 2.5% of Tier 1 capital with a level of 5% of Tier 1 capital.