The guidelines on interest rate risk and credit spread risk aim to establish criteria for the assessment and management of these risks in non-trading activities of financial institutions. They replace the 2018 guidelines and introduce new elements while maintaining continuity with the previous ones. Institutions must comply with these guidelines, which include specific provisions for the identification and…
This document is the final report of the "Guidelines on the management of interest rate risk and credit spread risk arising from non-trading book activities" published by the European Banking Authority (EBA) in October 2022. It is a regulatory guide of 91 pages (only the first 38 pages are provided) replacing the 2018 guidelines on the management of interest rate risk in the non-trading banking book (IRRBB). It specifies the criteria for identification, assessment, management, and mitigation of interest rate risk (IRRBB) and credit spread risk (CSRBB) related to non-trading activities. The scope covers financial institutions subject to Directive 2013/36/EU (CRD) and Regulation 575/2013 (CRR), as well as their non-trading activities, based on European requirements effective from June 30, 2023 (December 31, 2023 for CSRBB). The guide applies to institutions of all sizes and complexities, with a principle of proportionality.
The document addresses the management of interest rate risk (IRRBB) and credit spread risk (CSRBB) in the non-trading portfolios of financial institutions. This topic is crucial as these risks can significantly affect the economic value of equity and net interest income of banks, impacting their financial stability and ability to absorb market shocks (p. 3-4). The main findings are:
- The guidelines replace those of 2018, integrating new requirements from the revision of the CRD and CRR, notably on the assessment and monitoring of CSRBB, as well as on the definition of unsatisfactory internal systems for IRRBB assessment (p. 3-7).
- They harmonize practices with Basel standards while specifying European-specific elements, such as a prudent assumption of a weighted average maturity capped at five years for certain demand deposits (p. 6-7).
- They require institutions to explicitly identify, measure, monitor, and manage these risks, integrating impacts on economic value and net interest income, as well as fair value variations according to accounting treatment (p. 17-18).
- They define a robust governance framework, with clear responsibilities for the board of directors, controlled delegation, formalized policies and risk limits, adapted information systems, internal controls, and rigorous model validation (p. 21-33).
- They specify measurement methods, combining at least one economic value measure and one net interest income plus fair value variations measure, with appropriate shock and stress scenarios, including negative scenarios and reverse tests (p. 33-38).
- They introduce criteria to identify unsatisfactory internal IRRBB assessment systems, allowing supervisory authorities to impose the standardized method (p. 6).
Key recommendations are that institutions must integrate these guidelines into their risk management and internal capital adequacy assessment process (ICAAP), adapt their systems and models, ensure adequate governance, and report regularly to their governing bodies and competent authorities. Supervisory authorities must notify their compliance to the EBA before May 2, 2023 (p. 11-12, 16).
These guidelines were developed to respond to the mandates of Directive 2013/36/EU (CRD) as amended, which requires financial institutions to identify, assess, manage, and mitigate interest rate risk in the non-trading book (IRRBB) and to establish systems to assess and monitor credit spread risk (CSRBB) (p. 5-7). The guide replaces the previous 2018 guidelines, as part of the second phase of implementing Basel standards on IRRBB within the European Union, integrating regulatory developments and feedback (p. 5).
The objective is to specify detailed criteria for:
- Identification, management, and mitigation of IRRBB, whether institutions use internal systems, the standardized method, or the simplified method (p. 12).
- Assessment and monitoring of CSRBB, with a clear definition of scope and governance principles (p. 6-7, 12).
- Determination of unsatisfactory internal IRRBB systems, allowing supervisory authorities to impose the standardized method (p. 6).
The scope covers all instruments sensitive to interest rates and credit spreads in the non-trading book, including assets, liabilities, derivatives, and off-balance sheet commitments (p. 12-13). The guide also specifies proportional application modalities according to the size, complexity, and risk profile of institutions (p. 17).
Theme 1: Definitions and Scope
- IRRBB: risk of economic losses or income related to interest rate variations affecting sensitive instruments in the non-trading book, including gap risk, basis risk, and option risk (p. 12-13).
- CSRBB: risk related to credit spread variations on sensitive instruments, distinct from expected default risk (p. 13-14).
- Instruments concerned: assets, liabilities, derivatives, and off-balance sheet items sensitive to rates or spreads, excluding items deducted from own funds (p. 12-13).
Theme 2: Governance and Responsibilities
- The board of directors holds ultimate responsibility for IRRBB management, including strategy definition, risk appetite, limits, and model validation (p. 22-24).
- Delegation possible to management or an ALCO committee, with clear separation of risk-taking and control functions (p. 24).
- Formalized policies covering procedures, assumptions, measurement methods, option management, treatment of demand deposits, and annual review (p. 26-27).
- Rigorous internal controls, regular independent audits, and IT system management ensuring data quality and reliability (p. 27-30).
Theme 3: Measurement and Assessment of IRRBB
- Use of at least one economic value (EV) measure and one net interest income plus fair value variations (NII plus FV) measure (p. 33-34).
- Multiple recommended methods, including gap analysis, partial duration analysis, option inventory (p. 34).
- At least quarterly shock scenarios covering parallel and non-parallel shifts, basis risk, and negative scenarios (p. 35-36).
- Annual stress tests integrated into ICAAP, including reverse stress tests to identify extreme scenarios threatening solvency (p. 36-38).
- Prudent behavioral assumptions, notably on demand deposits, loan prepayments, and embedded options (p. 37-39).
Theme 4: Capital and Limits
- Internal capital for IRRBB must reflect risks measured on EV and NII plus FV, without double counting, and be documented in ICAAP (p. 19-21).
- Risk limits defined at consolidated and entity levels, adapted to size, complexity, and risk profile, with escalation procedures in case of breaches (p. 24-25).
- Consideration of hedging costs, margin volatility, and impact of accounting changes (p. 20-21).
Theme 5: Identification of Unsatisfactory Internal Systems
- Harmonized criteria for authorities to identify unsatisfactory internal IRRBB assessment systems, allowing imposition of the standardized method (p. 6).
Theme 6: CSRBB Management
- Clear definition of CSRBB and scope including all instruments sensitive to credit spreads (p. 13-14).
- Explicit and proportionate governance, identification, assessment, and monitoring requirements (p. 6-7).
Theme 7: Implementation and Reporting
- Mandatory application from June 30, 2023 (December 31, 2023 for CSRBB) (p. 16).
- Obligation for competent authorities to notify compliance before May 2, 2023 (p. 11).
- At least quarterly internal reports, adapted to different management levels, including exposures, assumptions, limits, stress test results, and audits (p. 29-32).
Findings:
- Institutions must explicitly manage IRRBB and CSRBB in their risk management and ICAAP processes, with measures covering economic value and net interest income plus fair value variations (p. 17-18).
- Internal systems must integrate all risk components, notably gap, basis, and option risk, and use multiple measurement methods adapted to complexity (p. 33-35).
- Shock and stress scenarios must be regular, covering different forms of rate and spread variations, including negative scenarios and reverse stress tests (p. 35-38).
- Governance must be robust, with clear responsibilities, documented policies, internal controls, and independent model validation (p. 21-33).
- IT systems must ensure quality, completeness, and traceability of data used for measurement and reporting (p. 27-30).
Assumptions:
- The assumption of a weighted average maturity capped at five years for certain demand deposits is introduced for a prudent approach (p. 6).
- Behavioral assumptions on prepayments, early withdrawals, and product migration must be justifiable, documented, and regularly reviewed (p. 37-39).
Interpretations:
- Integrated management of IRRBB and CSRBB risks is essential for the financial resilience of institutions.
- Combining economic and income measures allows a comprehensive view of short- and long-term risks.
Uncertainties:
- The precise impact of new behavioral assumptions, notably the five-year cap for deposits, will be closely monitored by the EBA to detect potential adverse effects (p. 7).
- The effectiveness of third-party models depends on their customization and deep understanding by institutions (p. 32-33).
The EBA concludes that these new guidelines provide a harmonized and strengthened framework for managing IRRBB and CSRBB risks, aligned with international standards while integrating European specificities (p. 3-7). They replace the 2018 guidelines and apply from June 30, 2023 (December 31, 2023 for CSRBB) (p. 16).
Institutions must:
- Implement robust internal systems, integrating complementary measures of economic value and net interest income plus fair value variations, with prudent and documented assumptions (p. 33-39).
- Ensure clear governance with effective involvement of management and the board of directors, formalized policies, internal controls, and independent model validation (p. 21-33).
- Define and apply risk limits consistent with their risk appetite, and integrate results into ICAAP (p. 19-25).
- Explicitly monitor and manage CSRBB, with processes adapted to size and complexity (p. 6-7, 12).
- Prepare regular and comprehensive internal reports for governance bodies (p. 29-32).
Competent authorities must notify their compliance before May 2, 2023 (p. 11). The EBA will continue its dialogue with stakeholders to monitor application and effects of measures, notably the five-year maturity limit on deposits (p. 7).
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