IRRBB Flashcards
(17 cards)
IRRBB Definition
Current or prospective risk to capital and earnings arising from the impact of adverse movements in interest rates on the banking book.
Sub-types:
- Gap risk: Differences in term structure of rate sensitive assets and liabilities in the banking book
- Basis risk: Risk associated with assets and liabilities in the banking book that have similar terms to repricing or maturity, but are tagged to different reference interest rates
- Option risk: Risk associated with options that are embedded in assets and liabilities in the banking book
Definition of CSRBB
Any kind of spread risk related to instruments with potential credit risk that is not explained by IRRBB and by the expected credit/jump to default risk
Types of CSRBB
- Market credit spread (credit risk premium): Premium embedded within the overall effective interest rate on an instrument that represents premium required by market participants given instrument’s credit quality
- Market liquidity spread (liquidity risk premium): premium embedded within overall effective interest rate on an instrument that represents the market appetite/liquidity for that instrument and the presence of willing buyers and sellers
PV01
Difference between NPV of cash flows on assets and NPV of cash flows on liabilities for a 1bp parallel shift in the yield curve
Limitations: parallel shift, no tenors
Gap analysis
- Group A&L by contractual/behavioural maturity buckets (*per next re-pricing date for floating rate instruments)
- Calculate difference A-L per bucket
Limitations
- snapshot view of b/s
- parallel shift assumed
- doesn’t capture uncertainties in asset performance or optionality
Earnings at Risk/NII sensitivity
- VaR with respect to NII for given confidence level & time horizon
- start with repricing gap analysis
- NII sensitivity = (gap.rmng term.change in int rates)/time horizon
- Apply a range of int rate shock scenarios
- Simulate change in NII over time horizon using stochastic process
E.g Vasicek int rate model
EVE
Measure change in NPV(all cash flows from A, L and off b/s) subject to specific int rate shock and stress scenarios
EV = PV(A) - PV(L)
Run-off basis over remaining life
Elements to consider: Behavioural modelling for option risk
- Prepayment risk (loans)
- Early redemption risk (term deposits)
- Drawdown risk (loans)
- NMD volatility risk (NMDs)
EVE supervisory shock scenarios
6 scenarios:
- parallel shock up and down
- steepener and flattener shocks
- short rates up and down
BCBS 368 IRR Principles
Important to Oversee Apps Should Dr M Report Caps on Public Supervision
1.IRRBB is Important and must be identified, measured and controlled
2. Board responsibility for framework, Oversight & risk appetite
3. Risk appetite in terms of risk to both EV and earnings
4. Measured based on EV and EAR, wide range of IR shocks
5. understand, test and document modelling assumptions
6. Systems and models based on accurate data. Models comprehensive and covered by model governance processes
7. Outcomes & hedging strategies regularly reported
8. IRRBB exposure and practices publicly disclosed regularly
9. IRRBB capital adequacy specifically included in ICAAP
10. Supervisors ensure soundness, effectiveness and publish criteria for identifying outlier banks
BCBS 368 Measures for IRR - EVE
- Aim: change in NPV of assets, liabilities and off b/s subject to interest rate shock and stress scenarios
- Horizon: long term measure, remaining life
- B/S assumption: run-off
BCBS 368 Measures for IRR - NII
- Aim: changes in future profitability within given time horizon affecting future levels of own equity capital
- Horizon: short to medium term (3-5yrs)
- B/S assumption: constant b/s
BCBS 368 IRR EVE standardised shock scenarios
6 supervisory shocks:
- parallel up and down
- steepener and flattener
- short rates up and down
Considerations for IRR internal shock scenarios for EVE
- shape/level of current int rate term structure
- historical and implied volatilities of int rate term structure
- effects of negative int rate scenarios on assets and liabilities
- adverse changes in spreads of new A&L
- changes in portfolio composition
EVE standardised framework
- Split BB positions:
- amenable, less amenable, non-amenable (certainty of cash flows) - Cash flow generation for 1 under each change in int rate scenario
- Aggregate and bucket cash flows from 2 to facilitate discounting
- Adjust for automatic int options using option pricing techniques
- Standardised EVE = max Delta EVE across int rate scenarios
Interest rate risk policy
- NIM: size and stability
- Types and Levels of IRR: component risks (re-pricing, basis, yield curve, option) , per tenor bucket & in aggregate
- Risk control: short and long term management & monitoring (procedures, controls, self-monitoring)
- independent process to measure and analyse risk
- Character of risk (complexity)
- vulnerability of earnings and capital under int rate changes
- relative volume and future prospects of stable funding
- risk positions relative to changing market conditions
Tools to manage IRRBB
- IRS: fixed vs floating, tenor and reference rate, index linked, swaptions
- HQ debt instruments: macro hedge, less costly than swaps, mismatch risk
- Sell repo: temp use of cash proceeds and temp reduce exposure
- Rolling hedges: cheaper & more flexible but reinvestment risk, basis risk and macro hedge rules
