Smart About Risk
 

Interest Rate Risk in the Banking Book

The interest rate risk in the banking book is one of the main risks of banks. While no capital requirement under Pillar I is set for this risk, it is a significant risk that affects the profitability and stability of the bank.

The introduction and maintenance of the IRRBB management system is required by Basel II / III regulation and the requirements for this system further specify the EBA Guidelines. The bigger the bank is, the higher the demands placed on it by the regulator are and the more sophisticated and complex the approach IRRBB has to be taken. ARM offers its services in the field of introducing or revising the IRRBB management system to all banks and similar entities.

Services Offered:

 

In the area of IRRBB we also offer professional seminars in the form of open and in-house seminars.
See our offer of CADCalc®Market a software tool for calculation of IRRBB.

 

The IRRBB Measurement and Management Methodology

  • Design of key processes needed for effective operation of the IRRBB system with regards to:
    • Requirements and objectives of the institution’s top management
    • Size and complexity of the institution
    • Relevant regulatory requirements and related standards
    • The system’s ability to respond flexibly to changes
  • General description of:
    • Approaches to modeling behavioral characteristics of portfolio (e.g. loan prepayment)
    • Models used to monitor the IRRBB size and validation rules
    • Creation of internal stress scenarios and standard stress test required by bank regulation
    • Risk management principles (limits, Risk Appetite)
  • Ensuring the interconnection of the proposed processes with other processes of the institution (e.g. process of measuring the market risk of trading portfolio, trading limits, etc.)
  • The IRRBB inclusion into the economic capital under Pillar II
  • Incorporation of the IRRBB system into the strategic management of the institution:
    • Definition of powers and responsibilities
    • The IRRBB system operation schedule with regard to related processes
  • Definition of target organizational arrangements and clarification of individual roles in the IRRBB system
  • The IRRBB strategy creation/revision, with the output of the above-stated areas taken into account
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Behavioral and Optional Characteristics

  • Creation of models for:
    • Loan prepayment – by reduction of either the loan maturity or the annuity installment
    • Irregular withdrawal from deposit accounts – early withdrawal from the account or the extension of the product period over and above the contract
    • Drawing of agreed frameworks – modeling the balance sheet amount based on the off-balance sheet amount
    • Current account balances – balance amount, period
  • Validation rules settings for created models  
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Net Interest Income (NII)

  • Setting rules for modeling scenarios of balance-sheet development:
    • Stable balance
    • Increasing balances based on a business plan
    • Decreasing balances based on expert assumptions on the development of the macroeconomic situation or other external influences (e.g. competitive struggle)
  • Designing time zones and a horizon for monitoring of NII
  • Developing a portfolio duration targeting concept
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Market Value of Equity (MVE) a Economic Value of Equity (EVE)

  • Designing valuation functions by product type
  • Incorporating behavioral assumptions into valuation functions
  • Setting rules for handling credit spreads in the valuation
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Earnings at Risk (EaR)

  • Designing time zones and a horizon for monitoring EaR
  • Designing a method for EaR calculation
  • Proposal for setting back-testing rules and related corrective measures / remedy actions.  
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Value at Risk (VaR)

  • Choice of reference period and a horizon for VaR calculation
  • Designing a method for VaR calculation (historical simulation / covariance matrix / Monte Carlo simulation / Expected Shortfall)
  • Proposal for setting back-testing rules and related corrective measures / remedy actions.  
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Stress Testing

  • Proposal of internal stress scenarios for:
    • Continuous internal management
    • Stress testing
  • Designing rules for the standard stress test evaluation required by banking regulation
  • Setting rules for updating stress scenarios 
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Internal Limits for Continuous Internal Management

  • Setting limit values for monitored indicators measuring the IRRBB amount
  • Design of escalation mechanisms and channels for early warning of limits being exceeded
  • Creation of a methodical procedure for revising the limit set should a change in institution strategy or business plan occur 
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Risk Appetite

  • Designing company Risk Appetite and ensuring its interconnection with:
    • Institution strategy
    • Business plan
  • Setting rules for Risk Appetite revision in the event of change in input assumptions (e.g. when introducing new product or a change in the external legislative environment, etc.)
  • Defining rules for Risk Appetite evaluation:
    • Evaluation frequency
    • Escalation mechanisms
    • Incorporating the evaluation into the internal reporting
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Internal Reporting

  • Creation of internal reporting rules in relation to behavioral characteristics of portfolio, measured by the IRRBB amount and internal limit system:
    • Provision of an information framework and level of detail with regard to various managerial levels (line management vs. senior management vs. board of directors)
    • Reporting frequency
    • Information flows
  • Help with interpretation of results
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