Interest rate risk in the banking book irrbb is part of the basel capital. As part of its ongoing efforts to address international bank supervisory issues, the basle committee on banking supervisioni is issuing the attached paper on the management of interest rate risk. However, with the growth in holdings of corporate securities and derivatives, credit risk in the trading book has increased. The risk that assets and liabilities reprice or mature at different times, causing margins between interest income and interest expense to narrow.
This is the traditional approach to interest rate risk assessment taken by many banks. Table 3 shows an example of credit risk economic capital allocations credit risk only determined using the pd and lgd parameters previously discussed and a model translation of those parameters into a credit risk capital charge. Issued in july 2004, this paper has the objective to support the pillar 2 approach to interest rate risk in the banking book within the basel ii capital framework. Var and credit risk in the trading book low sensitivity to extreme events banking book vs trading book arbitrage basel 2. Interest rate risk in the banking book irrbb bankinghub. The standards reflect changes in market and supervisory practices since the principles were first published in 2004, which is particularly pertinent in light of the current exceptionally low interest rates in many jurisdictions.
Exposures in equities not included in the trading book. Accordingly, effective risk management that maintains interest rate risks at prudent levels is essential to the safety and soundness of banking institutions. May 10, 2012 the really brief version imo is that, basically, banks could regulatory arbitrage by shifting from the banking book to the trading book. The banks have to provide the capital charge for interest rate risk in the trading book other than derivatives as per the guidelines given below for both specific risk and general risk after measuring the risk of holding or taking positions in debt securities and other interest rate related instruments in the trading book. Interest rate risk in the banking book irrbb refers to the current or prospective risk to the banks capital and earnings arising from adverse. Interest rate risk in the banking book and capital. Interest rate risk in the banking book is too dependent on the specific characteristics of institutions to enable a formalized capital requirement. Subdivision 3 capital subdivision 4 credit risk subdivision 5 market risk subdivision 6 operational risk subdivision 7 equity exposures subdivision 8 interest rate risk in the banking book subdivision 9 remuneration subdivision 10 composition of capital annex 11a breakdown in remuneration disclosures for senior management. The view expressed by the basel committee in the basel ii capital accord receives strong support.
The interest rate risk in banking book refers to the risk to a banks capital and earnings arising. Capital requirements regulation european banking authority. Any changes in interest rates have an impact on the present value of future cash flows on the bank. 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. Regulators take softer line on banks interest rate risk. The view expressed by the basel committee in the basel ii capital accord receives strong support from the data.
Information on the level of irrbb exposure and practices for. Pillar 1 minimum capital requirement, with both economic value and. One most note that the capital requirements under basel ii do not include liquidity risk, interest rate risk of banking book, strategic risk, and business risk. The interest rate risk in the banking book can be measured and controlled at present value or periodically. Meeting the practical challenges highlights the new basel committee on banking supervision bcbs standards for irrbb come into force january 1, 2018. Historically, credit risk was lodged mainly in the banking book. Current practices vary among banks and supervisors. In january 20, the basel committee has issued the full text of the revised liquidity coverage ratio lcr as one of the key component of the basel iii capital framework. Whitepaper implementing interest rate risk in the banking. Article interest rate risk in the banking book irrbb fis. 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. Capital adequacy framework basel ii riskweighted assets page 1 506 issued on.
However, this left many banks with insufficient capital to cover losses when credit markets collapsed during the crisis. Interest rate risk in the banking book zanders treasury. Principles for the management of interest rate risk summary 1. Interest rate risk management latest about banking. While it has been standard practice to use pvbased economic. The resulting bucketlevel capital charges are then aggregated to obtain the risk class level capital charge the same aggregation technique from step 2 is used in step 3 4 the aggregate capital charge is the sum of each riskclass level capital charge 27. The course will cover, stress testing, capital buffers, operational risk capital modelling, counterparty credit risk and many more topics. Banks must disclose, among other requirements, the impact of interest rate shocks on their. Irrbb practice towards comprehensive framework of interest rates risk. What is interest rate risk in the banking book irrbb. 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. Interest rate risk in the banking book irrbb march uk finance. A stricter threshold for identifying outlier banks, which is has been reduced from 20% of a banks total capital to 15% of a banks tier 1 capital.
It generally arises from repricing risk, risks related to the timing mismatch in the maturity and repricing of assets and liabilities and off. 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. 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 rates that affect banking book positions. Revised trading and banking book boundary for market risk 19 fig. The capital charge for interest rate related instruments and equities would apply to the current market value of these items. Differences between interest rate risk irr in the banking and. Capital requirements for overthecounter derivatives central. With the interest rate risk of the banking book, the basel committee on banking supervision. Proper conduct of banking business directive 1 5 management of interest rate risk page 3333 chapter 1 general foreword 1. Irrbb refers to the current or prospective risk to the banks capital and earnings arising from adverse movements in interest rates that affect the banks banking book positions.
This sets out the methodologies we will use to inform the setting of a firms pillar 2a capital requirement for credit risk, market risk, operational risk, counterparty credit risk, credit concentration risk, interest rate risk in the nontrading book hereafter referred to as interest. The capital charge for interest raterelated instruments and equities would apply to the current market value of these items. Basel iv revised trading and banking book boundary for market. Minimum capital requirements for interest rate risk in the banking book irrbb. If you would like to place an order please email email protected interest rate risk in the banking book. Whitepaper interest rate risk in the banking book irrbb. Guidelines on the management of interest rate risk arising from. Interest rate risk in the banking book hong kong dollar. This guide will help you to appreciate types of banks in operations in the country, models of commercial banking after abolition of universal banking in the country, relationships between customers and the banks and forms of collateral securities that can be accepted by banks for loans and advances, among others topics. Interest rate risk in the banking book irrbb definition. Its aim is to identify earnings volatility over a 12monthhorizon against the two instantaneous. Uniform financial institutions rating system trading and capital markets activities manual.
Diversification is a first line of defence against major credit losses. The new basel committee on banking supervision bcbs standards for irrbb come into force january 1, 2018. Its aim is to identify earnings volatility over a 12monthhorizon against the two instantaneous parallel shock scenarios. However, the assets are valued at their book value and a write down in asset value happens only in case of defaults. Although new accounting standards allow banks to use the fair value option for some securities, most assets and liabilities in the banking book are valued at book value as banks hold them to. The accord promotes strong risk management practices by providing capital incentives for banks having better risk management practices. Organizational structure of banks, banking regulations, interest rate risk management in banks, credit risk management in banks, liquidity management in banks, operational risk management in banks, market risk management in banks. A particular definition was introduced related to the interest rate risk capital charge. Revised trading and banking book boundary for market risk 11 total sample. We will now see how the capital requirement is worked out for the risk of holding or taking position in debt securities and other interest raterelated instruments in the trading book. 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. Section iv describes our approach to calculating ccps risk buffers for otcinterest rate swaps and otccds while section v describes our results. 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.
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. Interest rate risk in the banking book irrbb june uk finance. It generally arises from repricing risk, risks related to the timing mismatch in the maturity and repricing of. Evolution of the capital accord basel i basel iii basel i minimum risk based capital, definition of capital mra market risk treatment in the trading book.
Guidelines set the eba view of appropriate supervisory practices within. Internal risk transfers from the trading book to the banking book are not recognised under the framework. Banks need to ensure they can address all the requirements of the regulators whilst ensuring regulatory capital optimisation. The final standard updated a set of principles laid out in 2004, to reflect changes in the market and supervisory practices. While interest rate risk can arise from various sources, four key types of interest rate risk are common to community bank balance sheets. Supervisors should, on a regular basis, collect sufficient information from banks to be. The basel committee on banking supervision has today issued standards for interest rate risk in the banking book irrbb. The pras methodologies for setting pillar 2 capital. Historically, lower capital requirements for trading book assets had encouraged banks to shift assets from the more expensive banking book into the trading book. Nii, on the other hand, is always based on cash flows at client rates and thus represents total nii. 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.
Section vi concludes with a discussion on policy implications. An economic capital model integrating credit and interest. Apr 21, 2016 regulators take softer line on banks interest rate risk. Capital adequacy framework basel ii riskweighted assets. Working paper series no 1041 april 2009 1 introduction the committee remains convinced that interest rate risk in the banking book is a potentially significant risk which merits support from capital basel ii, 762, basel committee, 2006. Organizational structure of banks, banking regulations, interest rate risk management in banks, credit risk management in banks, liquidity management in banks, operational risk management in banks, market risk management in. Although the bcbs did not retain a minimum capital requirement mcr. Uniform financial institutions rating system trading and capitalmarkets activities manual. The handbook of interest rate risk management by jack clark francis author, avner simon wolf editor isbn. The conceptual contribution of the paper is to derive an economic capital model which takes account of credit and interest rate risk in the banking book. Basel capital rules for banks trading books will shift.
When interest rates change, the present value and timing of future cash flows change. Variation in earnings is an important focal point for interest rate risk analysis because reduced earnings or outright losses can threaten the financial stability of an institution by undermining its capital adequacy and by reducing market confidence. 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. For the trading book, specific methodologies were proposed. This paper looks at the standards from a practical implementation point of view and raises some of the main challenges. Treatment of interest rate risk in the banking book in latin.
Basel iv revised trading and banking book boundary for. According to industry reports, interest rate risk is after credit. The central counterparties dominating the market for the clearing of overthecounter interest rate and credit derivatives are globally systemic. 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.
Section iii describes ccps risk management frameworks and the models they use to calculate their capital requirements. Guidelines on the incremental default and migration risk charge irc. Managing capital and stress testing for traded book assets. Capital requirements toronto learn what capital management currently looks like the financial industry in toronto. Capital requirements for overthecounter derivatives. Information on the level of irrbb exposure and practices for measuring and. Here the banks typically accept credit risk and interest rate risk.
Introduction the committee remains convinced that interest rate risk in the banking book is a potentially significant risk which merits support from capital basel ii, paragraph 762, basel committee, 2006. Among them, interest rate risk receives special attention, as expected. In particular, loans that would have been charged for credit risk, at oneyear 99. Scenarios once the scope of the interest rate risk method has been determined, then consideration can be given to the scenarios with interest rate shocks that will be used in the. Interest rate risk in the banking book irrbb is a banks exposure to adverse movements in interest rates and the.
Interest rate risk is an integral part of banking business, and may even be a. This course note intends to introduce students to bank administration with emphasize on its risk management practices. Interest rate risk management at community banks community. Employing methodologies similar to the calculation of banks capital requirements against trading book exposures, this paper assesses. 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. Supervisors should, on a regular basis, collect sufficient.
906 524 467 1618 433 146 115 1387 1638 1570 785 872 1633 1151 1474 1014 432 1217 1549 644 407 1116 89 1015 322 356 169 1247 930 1489 1300 1155 1481 752 517 1263 102 918 1261 153 130