4.4 Measurement

Institutions should implement robust internal measurement systems (IMSs) that capture all components and sources of IRRBB which are relevant for the institution’s business model.

Institutions should measure their exposure to IRRBB in terms of potential changes to both the economic value (EV) and earnings. Institutions should use complementary features of both approaches to capture the complex nature of IRRBB over the short-term and long-term time horizons. In particular, institutions should measure and monitor (i) the overall impact of key modelling assumptions on the measurement of IRRBB in terms of both economic value measures and earnings measures, and (ii) the IRRBB of their banking book interest rate derivatives where relevant for the business model.

If commercial margins and other spread components are excluded from economic value measures, institutions should (i) use a transparent methodology for identifying the risk-free rate at inception of each instrument; and (ii) use a methodology that is applied consistently across all interest rate sensitive instruments and all business units.

When calculating earnings measures, institutions should include commercial margins.

Institutions should consider non-performing exposures (net of provisions) as interest rate sensitive instrumen ts reflecting expected cash flows and their timing.

When measuring their exposure to IRRBB, institutions should not purely rely on the calculation and outcomes of the supervisory outlier tests as described in section 4.5, or any additional outlier test developed by the competent authority, but should develop and use their own assumptions and calculation methods. However, the supervisory outlier tests should be fully integrated into the internal framework for the management of IRRBB and should be used as complementary tools for measuring exposure to IRRBB.

4.4.2 Methods for measuring IRRBB

Institutions should not rely on a single measure of risk but should instead use the range of quantitative tools and models that corresponds to their specific risk exposure. To that end, institutions should consider the application of the methods listed in Annex I but not limited to those, to ensure that various aspects of interest rate risk are captured adequately.

The limitations of each quantitative tool and model used should be fully understood by the institution, and these limitations should be taken into account in the IRRBB risk management process. In assessing IRRBB, institutions should be aware of the risks that may arise as a consequence of accounting treatment of transactions in the non-trading book.

Institutions should identify and measure all components of IRRBB. In order to identify different components of IRRBB, institutions should at least consider those approaches as shown in Table 1.

Table 1: Identification of sub-components of interest rate risk in the non-trading book

Gap risk

a) Behavioural assumptions for customer accounts with embedded customer optionality

b) Behavioural assumptions for customer accounts without specific repricing dates

c) Corporate planning assumptions for own equity capital