When interest rates change, the present value and timing of future cash flows also changes, which necessarily implies changes to the underlying value of a bank’s assets, liabilities and off-balance sheet items of credit institutions. Furthermore, it also affects bank’s earnings by altering interest rate-sensitive income and expenses, affecting its net interest income.
Therefore, the interest rate risk is inherent to the banking activity and its effective management impacts significantly to institutions’ profitability.
To date, the risk of interest rate to which the positions of the investment portfolio are subject was part of Pillar 2 of the Basel II framework.
- In this context, in April 2016 the BCBS published the final standards which update the Pillar 2 Principles with the aim of adapting them to the changes in supervisory and market practices regarding to the IRRBB management.
- During the consultative period that began in June 2015, the industry expressed the complexity of implementing the approach of Pillar 1 proposed by the BCBS in its consultation document, so finally the BCBS has decided to maintain the Pillar 2 approach, reviewing the existing Principles.
- Nevertheless, the BCBS document also provides a standardised method that supervisors may require institutions to implement, or that these institutions could adopt on a voluntary basis.
This document prepared by the R&D area of Management Solutions analyses the requirements introduced by the updated Principles and the standardised method.
As a result of the approval of this new framework, institutions should be adapted to the updated Principles. The standardised method should only be implemented if it is required by the supervisor, although entities may adopt it on a voluntary basis.
Scope of application
Large internationally active banks on a consolidated basis. Nevertheless, supervisors have national discretion to apply the IRRBB framework to other institutions.
- The revised IRRBB Principles, including an overview of the principles for banks and principles for supervisors.
- The standardised method, including an overview of the six stages considered: stage 1 (classification of cash flows), stage 2 (allocation of cash flows in each bucket), stage 3 (calculation of the change of the EVE for each scenario), and stages 4 and 5 (calculation of the add-on and capital minimum requirements for the IRRBB).
Download the technical note by clicking here.