Component Method Focus

For measuring and monitoring of IRRBB, institutions should use at least one net interest income measure plus market value changes and at least one economic value measurement method that, in combination, capture all components of IRRBB. Large institutions with cross-border activities, in particular institutions under categories 1 and 2 of the SREP Guidelines, and institutions with complex or sophisticated business models, should use multiple measurement methods for IRRBB, as further specified in Annex II.

4.3.3 Interest rate shock scenarios for ongoing management

Institutions should regularly, at least quarterly and more frequently in times of increased interest rate volatility or increased IRRBB levels, measure their exposure to IRRBB in the context of the different IRRBB measures under various interest rate shock scenarios for potential changes in the level and shape of the interest rate yield curves, and to changes in the relationship between different interest rates (i.e., basis risk).

Institutions should consider whether to apply a conditional or unconditional cash flow modelling approach. Larger and more complex institutions, in particular institutions under categories 1 and 2 of the SREP Guidelines, should also take into account scenarios where different interest rate paths are computed and where some of the assumptions (e.g., relating to behaviour, contribution to risk, and balance sheet size and composition) are themselves functions of changing interest rate levels.

Institutions should assess exposures in each currency in which they have positions. For the material currency exposures, the interest rate shock scenarios should be currency-specific and consistent with the underlying economic characteristics. Under the IRRBB internal measurement system (IMS), currency-specific interest rate shock scenarios, should be considered, at least, for each currency where the accounting value of financial assets or liabilities denominated in a currency amounts to 5% or more of the total non-trading book financial assets or liabilities, or less than 5% if the sum of financial assets or liabilities included in the calculation is lower than 90% of total non-trading book financial assets (excluding tangible assets) or liabilities. Institutions should include in their internal measurement systems methods to aggregate their IRRBB across different currencies. Where institutions make use of assumptions about dependencies between interest rates in different currencies, they should have the necessary level of skills and sophistication to do so. Institutions should take into account the impact of assumptions regarding dependencies between interest rates across different currencies.

When selecting interest rate shock scenarios, institutions should consider the following:

• (a) That their own internally developed interest rate shock scenarios be commensurate with the nature, scale and complexity of their activities as well as their risk profile, taking into account sudden and gradual parallel and non-parallel shifts and changes in the yield curves. Scenarios should be based on the historical movements and behaviour of interest rates, as well as simulations of future interest rates;
• (b) Interest rate scenarios that reflect changes in the relationships between key market rates in order to address basis risk;
• (c) The prescribed interest rate shock scenarios as referred to in paragraph 5 of Article 98 of Directive 2013/36/EU;
• (d) Any additional interest rate-shock scenarios required by supervisors;
• (e) That the validity of diversification assumptions is appropriately stressed; and
• (f) In low interest rate environments, institutions should also consider negative interest rate scenarios and the possibility of asymmetrical effects of negative interest rates on their interest rate sensitive instruments.

The results of shock scenarios should feed into the decision-making at appropriate management level. This includes strategic or business decisions, the allocation of internal capital, and risk management decisions by the management body or its delegates. The results should also be considered when establishing and reviewing the policies and limits for IRRBB.

4.3.4 Interest rate stress scenarios

IRRBB stress testing should be considered in the ICAAP, where institutions should undertake rigorous, forward-looking stress testing that identifies the potential adverse consequences of severe changes in market conditions on their capital or net interest income measures plus market value changes. For the purpose of IRRBB stress testing institutions should include changes in the behaviour of their customer base. Stress testing for IRRBB should be integrated into institutions’ overall stress -testing framework, including reverse stress testing, and should be commensurate with their nature, size and complexity, as well as their business activities and overall risk profile.

IRRBB stress testing should be performed regularly, at least annually and more frequently in times of increased interest rate volatility and increased IRRBB levels.

The IRRBB stress-testing framework should include clearly defined objectives, scenarios tailored to the institution’s businesses and risks, well -documented assumptions and sound methodologies.

In enterprise-wide stress tests, the interaction of IRRBB with other risk categories (credit risk, liquidity risk, market risk, etc.), and any material second-round effects, should be computed.

Institutions should perform reverse stress tests in order to (i) identify interest rate scenarios that could severely threaten an institution’s capi tal, economic value and net interest income measures plus market value changes; and (ii) reveal vulnerabilities arising from its hedging strategies and the potential behavioural reactions of its customers.

For IRRBB assessment purposes, in testing vulnerabilities under stressed conditions, institutions should use larger and more extreme shifts and changes in interest rates than those used for the purpose of ongoing management, including at least the following:

• a) Substantial changes in the relationships between key market rates (basis risk);
• b) Sudden and substantial shifts in the yield curve (both parallel and non-parallel);
• c) Breakdowns of key assumptions about the behaviour of asset and liability classes;
• d) Changes in key interest rate correlation assumptions;
• e) Significant changes to current market and macro conditions and to the competitive and economic environment, and their possible development; and
• f) Specific scenarios that relate to the individual business model and profile of the institution.

The results of stress scenarios should feed into the decision-making at the appropriate management level. This includes strategic or business decisions, the allocation of internal capital, and risk management decisions by the management body or its delegates. The results should also be considered when establishing and reviewing the policies and limits for IRRBB.

For the purpose of sensitivity analysis under stress scenarios, institutions should evaluate, in the economic value metrics, the limitations associated with the use of a run-off assumption and the ability of the institution to capture the long-term interest rate risk.

In cases where balance sheet instruments have significant repricing restrictions (e.g., caps and floors) institutions should prudently consider, if material, the effect that the renewal of said instruments would have when replaced with others with comparable features, regardless of the run-off assumption. This must be done for a prudent time horizon and considering the business model of the bank.

4.3.5 IRRBB measurement assumptions

When measuring IRRBB, institutions should fully understand and document key behavioural and modelling assumptions. These assumptions should be aligned with business strategies and be regularly tested. The determination of these assumptions should be made in a proportionate manner and particularly taking into account the materiality thresholds established in Articles 7(12), 8(2), 9(4), 11(3) and 21(1) of the regulatory technical standards envisaged in Article 84(5) of the CRD.

In assessing the risk of interest rate-sensitive products that are linked to inflation or other market factors, prudent assumptions should be applied. These assumptions can be based, for instance, on the current/last observed value, on forecasts of a reputable economic research institute or on other generally accepted market practices (in the case of inflation: forward inflation expectation curves, for instance).

When measuring IRRBB, pension obligations and pension plan assets should be included unless their interest rate risk is captured in another risk measure.

Institutions should, in relation to the different IRRBB measures, where applicable, take into account assumptions made for the purpose of risk quantification in relation to at least the following areas:

• a) The exercise of interest rate options (automatic or behavioural) by both the institution and its customer under specific interest shock and stress scenarios;
• b) The treatment of balances and interest flows arising from NMDs;
• c) The treatment of fixed term deposits with risk of early redemption;
• d) The treatment of fixed rate loans and fixed rate loan commitments;
• e) The treatment of own equity in internal economic value measures;
• f) The implications of accounting practices for the measurement of IRRBB, and in particular hedge-accounting effectiveness; and
• g) Validation of diversification assumptions.

As market conditions, competitive environments and strategies change over time, institutions should review significant measurement assumptions at least annually, and more frequently during rapidly changing market conditions.

• a) Behavioural assumptions for customer accounts with embedded customer optionality for the purpose of IRRBB

In assessing the implications of optionality, institutions should take into account:

• (a) The potential impact on current and future loan prepayment speeds arising from the interest rate scenario, underlying economic environment and contractual features. Institutions should take into account the various dimensions influencing the embedded behavioural options.
• (b) The elasticity of adjustment of product rates to changes in market interest rates.
• (c) The migration of balances between product types as a result of changes in their features, terms and conditions.

Institutions should have policies in place governing the setting of, and the regular assessment of, the key assumptions for the treatment of on- and off-balance-sheet items that have embedded options in their interest rate risk framework. This means that institutions should:

• (a) Identify all material products and items subject to embedded options that could affect either the interest rate charged or the behavioural repricing date (as opposed to contractual maturity date) of the relevant balances;
• (b) Have appropriate pricing and risk mitigation strategies (e.g., use of derivatives) to manage the impact of optionality within the risk appetite, which may include early redemption penalties chargeable to the customer as an offset to the potential break costs (where permitted);
• (c) Ensure that modelling of key behavioural assumptions is justifiable in relation to the underlying historical data, and based on prudent hypotheses;
• (d) Be able to demonstrate that they have accurate modelling (back-tested against experience);
• (e) Maintain appropriate documentation of assumptions in their policies and procedures, and have a process for keeping them under review;
• (f) Understand the sensitivity of the institution’s risk measurement outputs to these assumptions, including undertaking stress testing of the assumptions and taking the results of such tests into account in internal capital allocation decisions; and
• (g) Perform regular internal validation of these assumptions to verify their stability over time and to adjust them if necessary.

Non-maturity deposits from financial customers should not be subject to behavioural modelling except if they are operational deposits as defined in Article 27(1)(a) LCR Delegated Regulation.

Except for the regulated savings referred to in paragraph (a) of Article 428f(2) of the CRR, but not limited to the centralised part, and for those with material economic or fiscal constraints in case of withdrawal, the assumed behavioural repricing date for retail deposits and wholesale deposits from non-financial customers and operational deposits referred to in paragraph 110, without any specific repricing dates (non-maturity deposits), should be constrained to a maximum weighted average repricing date of 5 years. The 5-year cap applies to the full amount (i.e., core and non-core) of the aggregate portfolio of those deposits and separately for each currency.

In making behavioural assumptions about accounts without specific repricing dates for the purposes of interest rate risk management, institutions should:

• (a) Be able to identify ‘core’ balances – i.e., deposits that are stable and unlikely to reprice even under significant changes in interest rate environment, and/or other deposits whose limited elasticity to interest rate changes could be modelled by banks.
• (b) Modelling assumptions for these deposits should reflect depositor characteristics (e.g., retail/wholesale) and account characteristics (e.g., transactional/non-transactional). A high-level description of the above categories can be found below:
• i. Retail transactional deposits include non-interest-bearing and other retail accounts whose remuneration component is not relevant in the client’s decision to hold money in the account.
• ii. Retail non-transactional deposits include retail accounts (including regulated ones) whose remuneration component is relevant i n the client’s decision to hold money in the account.
• iii. Wholesale deposits include accounts from corporate and other wholesale clients, excluding interbank accounts or other fully price-sensitive ones.
• (c) Assess the potential migration between deposits without specific repricing dates and other deposits that could modify, under different interest rate scenarios, key behavioural modelling assumptions.
• (d) Consider potential constraints on the repricing of retail deposits in low or negative interest rate environments and the effect that such constraints may have on the stability of deposits under different interest rate scenarios.
• (e) Ensure that assumptions about the decay of core and other modelled balances are prudent and appropriate in balancing the benefits to net interest incomes against the additional economic value risk entailed in locking in a future interest rate return on the assets financed by these balances, and the potential forgone revenue under a rising interest rate environment.
• (f) Emphazising the importance of statistical or quantitative methods to determine the behavioural repricing dates and the cash flow profile of NMDs, the determination of appropriate modelling assumptions for NMDs may require (i.e., in a forward-looking perspective) the complementary contribution from different experts within an institution (e.g., risk management and risk control department, sales and treasury).
• (g) Have appropriate documentation of these assumptions in their policies and procedures, and a process for keeping them under review.
• (h) Understand the impact of the assumptions on the institution’s own chosen risk measurement outputs and internal capital allocation decisions, including by periodically calculating sensitivity analyses on key parameters (e.g., percentage and maturity of core balances on accounts and pass-through rate) and the measures using contractual terms rather than behavioural assumptions to isolate the impact of assumptions on the different IRRBB measures.
• (i) Undertake stress testing to understand the sensitivity of the chosen risk measures to changes in key assumptions, taking the results of such tests into account in internal capital allocation decisions.