Measuring interest rate risk in the banking book

Jun 25, 2019 a general rise in interest rates may boost earnings of a bank, but it would normally cause a decrease in the economic value of equity because of the basic inverse relationship between asset values. For an adequate management of interest rate risk, a removal of this risk to the first pillar of the basel accord is necessary figure 7. Measurement outcomes of irrbb and hedging strategies should be. Jan 01, 2000 measuring interest rate riskthat is, the risk that interest rate fluctuations might impair a firms profitability or viabilityis important both to financial institutions and to their regulators. Interest rate risk in the banking book irrbb definition. What is interest rate risk in the banking book irrbb. Further, a quantitative metric measuring the size of an institutions assets should not be the sole factor in determining the level of sophistication of an institution.

Srp98 application guidance on interest rate risk in the. Vice president, interest rate risk in the banking book. Interest rate risk an overview sciencedirect topics. Standards on the interest risk in the banking book irrbb.

The immediate impact of changes in interest rates is on the net interest income nii. Interestrate risk in the banking book irrbb regtech. Interest rate risk in the banking book how to manage. Bcbs proposals for interest rate risk in the banking book irrbb. Interest rate risk in the banking book is the risk posed by adverse movements in interest rates that cause a mismatch between the rates banks set on customer loans and on deposits. An numerical example for the interestrate risk for banks. In the present value perspective, the risk is quantified as an economic value change of the total banking book cash flow in case of changes in the yield curve. So, this method is an incomplete measure of the true interest rate exposure of a bank. This began in june 2004 when the basel committee on banking supervision bcbs released the revised capital. A change in interest rate has direct impact on their market value. Using an economic value of equity eve measure, interest rate risk exposure is measured against several interest rate shock scenarios ie parallel up and. Next, a survey of the interest rate environment of banks is carried out to identify the sources of interest rate risk.

Interest rate risk in the banking book is too dependent on the specific characteristics of institutions to enable a formalized capital requirement. Generally, methods for measuring interest rate risk focus on the duration of financial instruments, which is one way to characterize the sensitivity of their values to interest rate changes. In a world of low interest rates, the thought of what could happen if there is a sudden interest rate shock is very much at the forefront of bankers minds. For example, if rates were to increase and a banks deposits repriced sooner than its loans, it could result in the bank paying out more interest on deposits than the interest it is receiving from loans. Duration or interval is a critical measure for the interest rate sensitivity of assets and liabilities. Osfi believes that a control framework that manages this risk to prudent levels is a fundamental component of. The requirement imposed on all banking corporations to allocate adequate capital against all the risks in their business, including interest rate risk, is dealt. Deutsche bank annual report 2017 nontrading market risk. Avantage reply interest rate risk in the banking book 2015 qis, february 2015 page 3 interest rate risk in the banking book 2015 qis february 2015 measurement. Feb 14, 2017 this article first defines interest rate risk. Banks need to strike a balance between longterm and shortterm indicators that is aligned with the overall risk profile of the particular banks and at the same time avoiding potential. The purpose of this seminar is to give you a good understanding of tools and techniques for measuring, managing and reporting interest rate risk in financial institutions. Gap is the difference between the book value of the rate sensitive assets and the rate sensitive liabilities. Meeting the practical challenges moodys analytics introduction in a world of low interest rates, the thought of what could happen if there is a sudden interest rate shock.

The way ahead executive summary interest rate risk in banking book irrbb refers to the current or prospective risk to a banks capital and earnings arising from adverse movements in interest. Interest rate risk in the banking book irrbb bankinghub. Banks earn returns to shareholders by accepting and managing risk, including the risk that borrowers may. Essentials of effective interest rate risk measurement. Interest rate risk in the banking book irrbb is part of the basel capital. Greater volatility in interest rates, greater sensitivity of bank liabilities to interest rate differentials, and shifts in composition of bank asset and liability portfolios are. We start with a general introduction to interest rate risk and explain the sources and effects of this type of risk.

Interest rate risk in the banking book, quantitative easing, monetary policy, economic value of equity eve, earnings at risk ear. The interest rate risk in banking book refers to the risk to a banks capital and earnings arising from adverse movements in interest rates that affect banking book positions. Whitepaper implementing interest rate risk in the banking. Measuring and controlling interest rate and credit risk provides keys to using derivatives to control interest rate risk and credit risk, and controlling interest rate risk in a mortgagebacked securities derivative portfolio. Measuring interest rate risk for the banking book by meera. The basel committee on banking supervision has today issued standards for interest rate risk in the banking book irrbb. Interest rate risk in the banking book, written by industry expert paul newson, provides a thorough guide to the new regulatory requirements surrounding irrbb and demonstrates the importance of good governance the author explains the nature of interest rate risks in simple language, describing the methods typically used to measure them, with the added advantage of many worked examples. Measuring and controlling interest rate and credit risk. Any changes in interest rates have an impact on the present value of future cash flows on the bank. Guidelines on technical aspects of the management of. A general rise in interest rates may boost earnings of a bank, but it would normally cause a decrease in the economic value of equity because of the basic inverse relationship between asset values. An analysis of commercial bank exposure to interest rate risk david m. Essentials of effective interest rate risk measurement by emily greenwald, assistant vice president, federal reserve bank of chicago and doug gray, managing examiner, federal reserve bank of kansas city. Interest rate risk in the banking book irrbb irrbb overview interest rate risk in the banking book irrbb is the risk to earnings or capital arising from movement of interest rates.

Interest rate risk has the potential to create adverse effects on the financial results and capital of the bank arising from positions in the banking book. Interest rate risk in the banking book, quantitative easing, monetary policy, economic value of. The level of sophistication and complexity of individual methods varies. Interest rate risk in the banking book objective and key requirements of this prudential standard this prudential standard sets out the requirements that an authorised deposittaking institution must meet in relation to interest rate risk in the banking book. Interest rate risk in the banking book irrbb refers to the current or. Whitepaper interest rate risk in the banking book irrbb. It generally arises from repricing risk, risks related to the timing mismatch in the maturity and repricing of assets and liabilities and off. Vice president, interest rate risk in the banking book, business support and analysis team team the individual will work in interest rate risk irr team within citis corporate treasury. Interest rate risk in the banking book interest rate risk in the banking book irrbb can be a significant risk for banking institutions and new regulations will have a significant impact on their risk management frameworks. This chapter describes requirements on assessing interest rate risk in the banking book, ie the current or prospective risk to a banks capital and to its earnings, arising from the impact of adverse movements in interest rates on its banking book. Implementing bcbs 368 interest rate risk in the banking. In professional literature1 the most frequently stated are the analysis of maturity and repricing tables, or simply termed gap analysis, the duration gap method, the.

An earningsbased measure analyses the interest rate risk profile of the banking book in a detailed way tailored to the banks specific circumstances. In the present value perspective, the risk is quantified. Measuring interest rate riskthat is, the risk that interest rate fluctuations might impair a firms profitability or viabilityis important both to financial institutions and to their regulators. Rajesh kumar, in strategies of banks and other financial institutions, 2014. The management of interestrate risk in the banking book irrbb has been. This bulletin alerts banks to the importance of measuring the cash flow and valuation risks for assets and liabilities with embedded options. As it can account for new business, it reflects a full goingconcern perspective. Stricter standards, market changes and increased regulatory scrutiny will require many banks to improve their irrbb measurement tools, and. This book includes information on measuring yield curve risk, swaps and exchangetraded options, tc options and related products, and describes how to measure and.

Osfi believes that a control framework that manages this risk to prudent levels is a fundamental component of sound banking practice. Methods of measuring interest rate risk for measuring interest rate risk banks use avariety of methods. How pwc can help identify banking book on and offbalancesheet interest rate risk exposures, establish behavioural assumptions and conduct behavioural model validations. Institutions should be able to measure both the present value and the periodic interest rate risk in various different interest rate scenarios in order to ensure the risk. These standards are intended to replace an earlier guidance set out in the 2004 principles for the management and supervision of interest rate risk4, which laid out the principles and the methods expected to be used by banks for measuring, managing, monitoring and. With the interest rate risk of the banking book, the basel committee on banking supervision bcbs 1 aims primarily to address the potential loss of economic value of institutions from a change in the interest rates called irr and credit spread risk csr in the banking book 2.

The interest rate risk in the banking book can be measured and controlled at present value or periodically. Interest rate risk in the banking book zanders treasury. Leeto tlou and jonathan hacker provided assistance. Interest rate risk in banking book irrbb refers to the current or prospective. The standards revise the committees 2004 principles for the management and supervision of interest rate risk, which set out supervisory expectations for banks identification, measurement, monitoring and control of irrbb as well as its supervision. Using an economic value of equity eve measure, interest rate risk. Director, interest rate risk in the banking book, business. Due to the heterogeneous nature of this risk, it is captured in pillar 2. Section ii presents the proposal for a standardised pillar 1 capital framework for irrbb. The final standards do not specify how sophisticated the irrbb measurement quantitative techniques should be. Interest rate risk exists in an interestbearing asset, such as a loan or a bond, due to the possibility of a change in the assets value resulting from the variability of interest rates. Specifically, the potential exclusions for category 4 and 5 banks are. Sep 08, 2010 the management of interest rate risk should be one of the critical components of market risk management in banks. The regulatory restrictions in the past had greatly reduced many of the risks in the banking system.

Introduction interest rate risk in the banking book or irrbbas defined by the basel committeeis the current or. Eve is specifically used to measure banks irrbb in a standardised outlier test, with supervisors entitled to take action if a bank experiences a change in eve of. Introduction interest rate risk in the banking book or irrbbas defined by the basel committeeis the current or prospective risk to a bank s capital and earnings, arising from adverse movements in interest rates that affect. Interest rate risk in the banking book is the current or prospective risk, to both the groups capital and earnings, arising from movements in interest rates, which affect the groups banking book exposures. Topics include a survey of the operation and development of the banking system in the u.

Houpt, of the boards division of banking supervision and regulation, prepared this article. It generally arises from repricing risk, risks related to the timing mismatch in the maturity and repricing of. These guidelines on managing interest rate risk in the banking book are intended to provide guidance on designing the strategies and processes required for identifying, measuring, controlling and monitoring interest rate risks in the banking book. The interest rate risk in banking book refers to the risk to a banks capital and earnings arising. Director, interest rate risk in the banking book, business support and analysis team team the individual will work in interest rate risk irr team within citis corporate treasury. Nov 07, 2019 interest rate risk exists in an interest bearing asset, such as a loan or a bond, due to the possibility of a change in the assets value resulting from the variability of interest rates. Interest rate risk is the risk to current or anticipated earnings or capital arising from movements in interest rates. This course covers the nature and functions of money. Methods of measuring interest rate risk for measuring interestrate risk banks use avariety of methods. Interest rate risk is an important risk that can affect the safety and soundness of financial institutions. The management of interest rate risk should be one of the critical components of market risk management in banks. Overview interest rate risk in the banking book irrbb.

Deregulation of interest rates has, however, exposed them to the adverse impacts of interest rate risk. Feb 01, 20 this course covers the nature and functions of money. Nov 28, 2016 with the interest rate risk of the banking book, the basel committee on banking supervision bcbs 1 aims primarily to address the potential loss of economic value of institutions from a change in the interest rates called irr and credit spread risk csr in the banking book 2. An analysis of commercial bank exposure to interest rate risk. Interest rate risk irr is defined as the potential for changing market interest rates to adversely affect a banks earnings or capital. Measuring interest rate risk for mortgagerelated assets. Hence, when there is a variation in the interest rate, we can easily analyze the influence of the variation on the total interest income of the bank. This means that small institutions with a high level of inherent interest rate risk in the banking book irrbb might need a commensurate degree of oversight and controls in. The main drawback of this model is that this method considers only the book value of assets and liabilities and thus neglects their market value. Final report on guidelines on the management of interest rate risk arising from nontrading activities 4 measurement assumptions methods for measuring interest rate risk also covered in two annexes the governance of interest rate risk the identification, calculation and allocation of capital to interest rate risk. Aug 12, 2010 an numerical example for the interest rate risk for banks. Interest rate risk in the banking book irrbb is the risk to earnings or value and in turn to capital arising from movements of interest rates that affect banking book positions.