c) Corporate planning assumptions for own equity capital

Where institutions decide to adopt a policy intended to stabilise earnings arising from their own equity, they should:

• (a) have an appropriate methodology for determining what elements of equity capital should be considered eligible for such treatment;
• (b) determine what would be a prudent investment maturity profile for the eligible equity capital that balances the benefits of income stabilisation arising from taking longer-dated fixed-return positions against the additional economic value sensitivity of those positions under an interest rate stress, and the risk of earnings underperformance should rates rise;
• (c) include appropriate documentation of these assumptions in their policies and procedures, and include a process for keeping them under review;
• (d) understand the impact of the chosen maturity profile on the institution’s own chosen risk measurement outputs, including by regular calculation of the measures without inclusion of the equity capital to isolate the effects on both EVE and earnings perspectives; and
• (e) undertake stress testing to understand the sensitivity of risk measures to changes in key assumptions for equity capital, taking the results of such tests into account in their IRRBB internal capital allocation decisions.

In deciding the investment term assumptions for equity capital, institutions should avoid taking income stabilisation positions that significantly reduce their capability to adjust to significant changes in the underlying economic and business environment.

The investment term assumptions used to manage the risks to earnings and economic value sensitivity arising from equity capital should be considered as part of the normal corporate planning cycle, and such assumptions should not be altered just to reflect a change in the institution’s expectations of the path of future interest rates. Any use of derivative or asset portfolios to achieve the desired investment profile should be clearly documented and recorded.

Where an institution has not set explicit assumptions for the investment term of equity capital or sets assumptions that are explicitly short-term, the institution should make sure that its systems and management information can identify the implications of its chosen approach for the volatility of both earnings and economic value.