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    EBA Proposes Standards on Interest Rate Risk in the Banking Book

    December 02, 2021

    The European Banking Authority (EBA) launched three consultations on technical aspects of the revised framework capturing interest rate risks for banking book (IRRBB) positions, with the comment period ending on April 04, 2022. The proposals pertain to the draft regulatory technical standards on the IRRBB standardized approach; the draft guidelines on IRRBB and credit spread risk arising from non-trading book activities (CSRBB); and the draft regulatory technical standards on the IRRBB supervisory outlier test. These draft regulatory technical standards and guidelines have been developed on the basis of Article 84(5), 84(6), and 98(5a) of the Capital Requirements Directive or CRD.

    The regulatory technical standards on the IRRBB standardized approach specify criteria for the evaluation of IRRBB in case a competent authority decides its application in view of a non-satisfactory IRRBB internal system. The proposed draft regulatory standards specify standardized and simplified standardized methodologies to evaluate the risks arising from potential changes in interest rates that affect both the economic value of equity and the net interest income of an institution’s non-trading book activities in accordance with 84(5) of the Capital Requirements Directive (2013/36/EU). The simplified standardized approach reflects the generally less advanced capacities of smaller and non-complex institutions. To harmonize the calculation, EBA has specified common definitions, components, and steps for institutions to apply, which lead to estimates comparing the economic value of equity and net interest income between a baseline scenario and an interest rate shock scenario. Three main components are identified to estimate the level of net interest income within a given horizon: the aggregation of interest rate payments that are already fixed, the projection of risk-free yield, and the projection of commercial margin for repricing cash flows. To project risk-free yield with appropriate forward rates, additional slotting is needed based on original maturity. Additional components take into account automatic optionality and basis risk. Where possible, these proposals are based on the standardized methodology published by the Basel Committee on Banking Supervision in April 2016 as well as the practices established in the EBA Guidelines (EBA/GL/2018/02) on the management of interest rate risk arising from non-trading book activities from July 18, 2018. 

    The guidelines on IRRBB and CSRBB will replace the current guidelines on technical aspects of the management of interest rate risk arising from non-trading activities under the supervisory review process published in 2018. The updated guidelines provide continuity to the current ones and include new aspects of the mandate. In particular, they specify the criteria to identify non-satisfactory internal models for IRRBB management and identify specific criteria to assess and monitor CSRBB. The draft guidelines specify aspects of the identification, evaluation, management and mitigation of the risks arising from potential changes in interest rates and of the assessment and monitoring of credit spread risk, of institutions’ non-trading book activities. EBA is mandated to specify in these guidelines additional criteria for the assessment and monitoring by institutions of their credit spread risk arising from their non-trading book activities (CSRBB). The draft guidelines provide a definition and the scope of application of CSRBB. They contain dedicated sections for CSRBB with specific provisions on the identification, assessment, and monitoring of CSRBB. Finally, the amended mandate requests the inclusion of criteria for determining whether the internal systems implemented by institutions for the purpose of evaluating IRRBB are not satisfactory, in which case a competent authority may require an institution to use the standardized methodology. After some general provisions, the new guidelines contain separate specific chapters for IRRBB and for CSRBB. The guidelines are broadly consistent with the Basel standards with some further elaborated sections following the Capital Requirements Directive mandate, particularly on CSRBB assessment and monitoring and non-satisfactory IRRBB internal systems. 

    The regulatory technical standards on IRRBB supervisory outlier tests specify the supervisory shock scenarios as well as the criteria to evaluate if there is a large decline in the net interest income or in the economic value of equity that could trigger supervisory measures. The draft standards take into account the current low interest rate environment, for example, in the determination of a post-shock interest rate floor. The draft regulatory standards specify supervisory shock scenarios, common modeling and parametric assumptions, and what constitutes a large decline for the calculation of the economic value of equity and of the net interest income in accordance with Article 98(5a) of the Capital Requirements Directive, In the Directive, a supervisory outlier test is envisaged to identify institutions of which, in the context of a shock scenario, the economic value of equity declines by more than 15% of their Tier 1 capital or their net interest income experiences a large decline. If any of these limits are breached, competent authorities, unless they consider notwithstanding the breach that the institution’s IRRBB management is adequate and that it is not excessively exposed to IRRBB, shall exercise their supervisory powers like setting additional own funds requirements, limitations of activities with excessive risks, specifying modeling and parametric assumptions, among others established in the Directive. As per its mandate the draft regulatory technical standards are inspired on the internationally agreed Basel standards.

     

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    Comment Due Date: April 04, 2022

    Keywords: Europe, EU, Banking, Basel, Standardized Approach, Regulatory Technical Standards, Regulatory Capital, IRRBB, Interest Rate Risk, CSRBB, Supervisory Outlier Tests, Shock Scenarios, Simplified Standardized Approach, CRD, EBA

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