Interest Rate Risk in the Banking Book (IRRBB)

IRRBB Measurement Methodology

• Development/assessment of methodology for measuring interest rate risk in the banking book
• Development/assessment of methodology for behavioral modeling of early loan prepayments or withdrawals from deposit accounts
• Setup/assessment of stress scenarios for ongoing and stress testing
• Development/assessment of the accuracy of the standard stress test calculation
• Setup/assessment of a system of limits for monitored indicators measuring the level of IRRBB
• Framework description/proposal of:
  • approaches to modeling behavioral characteristics of the portfolio (e.g., early loan repayments)
  • models used for monitoring the level of IRRBB and validation rules
  • stress testing, specifically:
    • internal stress scenarios for:
      • continuous internal management
      • stress testing
    • rules for the standard stress test evaluation required by banking regulation
    • rules for updating stress scenarios

Models and Calculations

• Behavioral and Optional Characteristics – creation/validation of models for:
  • loan prepayment – involving either a shortening of loan maturity or a reduction of the annuity payment
  • 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

• Net Interest Income (NII) 
  • Development/validation of models
  • 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

• Market Value of Equity (MVE) and Economic Value of Equity (EVE) 
  • Development/validation of models
  • Designing valuation functions by product type
  • Incorporating behavioral assumptions into valuation functions
  • Setting rules for handling credit spreads in the valuation

• 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

• 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
• Development/assessment of validation rules for the created models
• Expert assessment of the documentation quality and the extent to which IRRBB is incorporated into economic capital within Pillar 2

Expert Consulting in IRRBB Management

• Design/framework description of risk management principles:
  • Limits
    • design of escalation mechanisms and channels for timely warnings in case of limit breaches
    • development of a methodological procedure for revising the system of limits when the institution’s strategy or business plan changes
  • Risk appetite
    • development of the institution’s risk appetite and ensuring its alignment with the institution’s strategy and business plan
    • establishment of rules for revising the risk appetite in case of changes in underlying assumptions (e.g., introduction of a new product, changes in external legislative environment, etc.)
    • definition of rules for assessing the risk appetite (evaluation frequency, escalation mechanisms, and integration of results into internal reporting)
• Design of key processes necessary for the effective functioning of the IRRBB framework with regard to:
  • requirements and objectives of senior management
  • the size and complexity of the institution
  • relevant regulatory requirements and related standards
  • the system’s ability to respond flexibly to changes
• Ensuring interconnection of the proposed processes with other institutional processes (e.g., market risk measurement processes in the trading book, trading limits, etc.)
• Incorporation of IRRBB into economic capital under Pillar II
• Integration of the IRRBB framework into the institution’s strategic management, including:
  • definition of authorities and responsibilities
  • timetable for the functioning of the IRRBB framework in relation to associated processes
• Definition of the target organizational structure and clarification of individual roles within the IRRBB framework
• Development/revision of the IRRBB strategy, taking into account the outputs from the areas listed above