Following its 2015 consultation on IRRBB the Basel Committee has
decided to leave IRRBB within the Pillar 2 framework. There had
been a suggestion that it be brought into Pillar 1 but this was met
with strong opposition from the industry. Instead, Basel has
decided to expand its existing IRRBB guidance for Pillar 2 to take
account of market developments in recent years. A more methodical
approach to IRRBB assessment will be required. This is a further
example of the ongoing development of Pillar 2 into a more
prescriptive set of risk assessments that resemble the Pillar 1
The new Standardised Framework for assessment of IRRBB includes
prescribed interest rate shock scenarios which banks must use to
assess the sensitivity of their assets and income to interest rate
shifts. In addition to the prescribed scenarios, banks must develop
their own shock and stress scenarios for assessing their exposure
to IRRBB. With the permission of their regulator banks can use an
internal model to measure IRRBB instead of the Standardised
Framework, but these models will be subject to a strict internal
Banks will need to disclose details of their exposure to IRRBB
in a prescribed table. These disclosures will detail the potential
impact that a prescribed interest rate shock scenarios would have
on the economic value of equity and net interest income.
Regulators must identify 'outlier banks' - i.e. banks
that would experience a depletion of 15% of Tier 1 capital as a
result of the prescribed shock scenarios set out in these revised
standards. Further supervisory action will be required where a
review of a bank's IRRBB exposure reveals inadequate management
or excessive risk relative to a bank's capital, earnings or
general risk profile.
In the UK the PRA already assesses banks' exposure to IRRBB
under Pillar 2. Last year the PRA disclosed the IRRBB methodology
that it assesses banks against. This focuses on basis risk (risk of
rates changing), duration risk (where re-pricing of products is
mismatched across time buckets) and optionality risk (such as the
risk of early repayment of interest-bearing loans). As a result,
these newly released standards from Basel will not be an entirely
new process for UK banks to follow. However, banks will need to
familiarise themselves with those elements of the Basel standards
that differ from the existing PRA methodology, e.g. disclosure of
IRRBB and internal development of shock and stress scenarios.
The revised standards are due to be implemented by 2018. In
keeping with the scope of the Basel framework, they are aimed at
large internationally active banks. National supervisors can extend
their application to smaller banks if they wish. The experience in
Europe suggests that European policymakers and regulators will do
just that. Attention will now shift to European regulatory
authorities such as the European Commission as the industry watches
closely to see how these standards will be incorporated into
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guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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