Introduction

Guidance

(1) Interest rate risk in the Banking Book or IRRBB is the risk to earnings or capital arising from movement of interest rates. IRRBB arises from changing rate relationships among yield curves that affect bank activities (basis risk), from changing rate relationships across the spectrum of maturities (yield curve risk), and from interest- rate-related options embedded in bank products (option risk).

(2) IRRBB is normally a major source of risk for a bank and for Broker Dealers that deal on their own account (including underwriting on a firm commitment basis). IRRBB is a significant risk driver for banks whose Banking Book assets equal or exceed 15% of their total assets. IRRBB may arise from a number of sources, for example:

1. (a) risks related to the mismatch of repricing of assets and liabilities and off balance sheet short and long-term positions;
2. (b) risks arising from hedging exposure to one interest rate with exposure to a rate which reprices under slightly different conditions;
3. (c) risks related to the uncertainties of occurrence, timing, pricing or value of transactions, for example, when expected future transactions do not equal the actual transactions;
4. (d) risks arising from consumers redeeming fixed rate products when market rates change; and
5. (e) risks from underwriting on a firm-commitment basis

(4) This Chapter relates to Interest rate risk in the Banking Book. Interest rate risk in the Trading Book is addressed as part of Market Risk in Chapter 6 of BBR.

(5) This Chapter sets out the regulatory requirements in respect of a Bank’s obligation to manage effectively its exposure to Interest Rate Risk in the Banking Book (IRRBB). This Chapter aims to ensure that a Bank has a robust framework commensurate with the nature, scale and complexity of its operations, for managing its exposure to IRRBB. In that regard, this Chapter sets out requirements that a Bank:

1. (a) implement IRRBB management framework to manage, measure and monitor its exposure to IRRBB, in a manner commensurate with the nature, scale and complexity of its operations;
2. (b) develop and implement policies to identify, measure, assess, manage, control and mitigate IRRBB;
3. (c) address stress testing of the Bank’s exposures to IRRBB; and
4. (d) address the relationship between IRRBB and the ICAAP.

(6) The detailed requirements specifying the methodologies, guidance and, parameters in respect of the primary requirements outlined in this chapter are provided in the Banking Prudential Guideline (BPG) issued by the AFSA. The BPG also provides detailed guidance on the elements to be included in the policies, systems and controls for managing IRRBB, qualitative guidance and standards to be followed in meeting the rules in this chapter.

8.1. IRRBB - Risk Management Framework and Governance

Guidance

(1) Interest rate risk in the Banking Book or IRRBB is the risk to earnings or capital arising from movement of interest rates. IRRBB arises from changing rate relationships among yield curves that affect bank activities (basis risk), from changing rate relationships across the spectrum of maturities (yield curve risk), and from interest- rate-related options embedded in bank products (option risk).

(2) IRRBB is normally a major source of risk for a bank and for Broker Dealers that deal on their own account (including underwriting on a firm commitment basis). IRRBB is a significant risk driver for banks whose Banking Book assets equal or exceed 15% of their total assets. IRRBB may arise from a number of sources, for example:

1. (a) risks related to the mismatch of repricing of assets and liabilities and off balance sheet short and long-term positions;
2. (b) risks arising from hedging exposure to one interest rate with exposure to a rate which reprices under slightly different conditions;
3. (c) risks related to the uncertainties of occurrence, timing, pricing or value of transactions, for example, when expected future transactions do not equal the actual transactions;
4. (d) risks arising from consumers redeeming fixed rate products when market rates change; and
5. (e) risks from underwriting on a firm-commitment basis

(4) This Chapter relates to Interest rate risk in the Banking Book. Interest rate risk in the Trading Book is addressed as part of Market Risk in Chapter 6 of BBR.

(5) This Chapter sets out the regulatory requirements in respect of a Bank’s obligation to manage effectively its exposure to Interest Rate Risk in the Banking Book (IRRBB). This Chapter aims to ensure that a Bank has a robust framework commensurate with the nature, scale and complexity of its operations, for managing its exposure to IRRBB. In that regard, this Chapter sets out requirements that a Bank:

1. (a) implement IRRBB management framework to manage, measure and monitor its exposure to IRRBB, in a manner commensurate with the nature, scale and complexity of its operations;
2. (b) develop and implement policies to identify, measure, assess, manage, control and mitigate IRRBB;
3. (c) address stress testing of the Bank’s exposures to IRRBB; and
4. (d) address the relationship between IRRBB and the ICAAP.

(6) The detailed requirements specifying the methodologies, guidance and, parameters in respect of the primary requirements outlined in this chapter are provided in the Banking Prudential Guideline (BPG) issued by the AFSA. The BPG also provides detailed guidance on the elements to be included in the policies, systems and controls for managing IRRBB, qualitative guidance and standards to be followed in meeting the rules in this chapter.

8.2. Powers of the AFSA

A Bank must hold adequate capital to effectively mitigate its exposure to IRRBB. The AFSA may impose a capital requirement on a Bank based on the Bank’s ICAAP, if the AFSA is of the view that the Bank’s capital is insufficient to cover its exposure to IRRBB.

8.3. IRRBB Management – Processes and Standards

(1) A Bank must not use an assumption or adjustment relating to the Bank’s exposure to IRRBB unless the assumption or adjustment has been approved by its governing body, or a relevant committee of its governing body. The AFSA may require a Bank to seek its explicit approval before using an assumption or adjustment.

(2) If required to do so by the AFSA, the Bank must demonstrate how the Bank used an assumption or adjustment (whether or not the AFSA required the assumption or adjustment to be approved).

(3) A Bank must set a prudent limit on the extent to which floating-rate exposures are funded by fixed-rate sources (and vice versa). In floating-rate lending, the Bank must set a prudent limit to the extent to which it runs any basis risk that would arise if lending and funding were not based on identical market interest rates.

(4) A Bank must set a prudent limit on the extent to which floating-rate exposures are funded by fixedrate sources (and vice versa). In floating-rate lending, the Bank must set a prudent limit to the extent to which it runs any basis risk that would arise if lending and funding were not based on identical market interest rates.

(5) A Bank must identify the effect of IRRBB before it introduces a new product or activity. The Bank must consider managing the effect through hedging (using swaps or other derivatives).

8.4. Stress Testing and IRRBB

(1) A Bank must carry out an evaluation of its exposure to IRRBB, in each currency in which 5% or more of its Banking Book assets or Banking Book liabilities is denominated. This evaluation must be carried out at least on an annual basis.

(2) A Bank must carry out stress-testing of its exposures to IRRBB at least on a quarterly basis. This stress-testing must:

1. (a) determine the re-pricing gap between the Bank’s assets and liabilities, before and after the effect of derivative instruments is taken into consideration;
2. (b) determine the effect of a sudden and unexpected parallel change in interest rates of 200 basis points in both directions, on the Bank’s net interest income from the forecast Banking Book; and
3. (c) apply a 200 basis point shock to each material currency in which 5% or more of its Banking Book assets or Banking Book liabilities is denominated.

(3) The AFSA may, in writing, specify a different level of interest rate shock as compared to the standard 200 basis point shock, for specific Banks.

(4) A Bank must include appropriate scenarios in its stress-testing to measure the Bank’s vulnerability to loss under adverse interest rate movements. In determining the effect of a rate change on its net interest income, the Bank must not assume that the rate will become negative.

(5) A Bank must report the results of its stress-testing to the AFSA, in the form prescribed by the AFSA.

(6) A Bank must immediately notify the AFSA, if any stress-testing under this Chapter involving an interest rate shock described in (2) above, indicates a potential decline in the economic value of the bank by an amount exceeding 20% of its Total Capital as defined in Chapter 4 of BBR.

8.5 Frequency of stress testing

(1) A Bank must carry out the stress testing required by Rule 8.4 (2) as frequently as necessary for it to be reasonably satisfied that it has at all times a sufficient understanding of the degree to which it is exposed to the risks referred to in that rule and the nature of that exposure. In any case it must carry out those evaluations no less frequently than required by Rule 8.4 (2).

(2) In order to carry out effectively the stress testing requirements specified in Rule 8.4 (2), a Bank must include appropriate scenarios into its stress testing programmes for measuring its vulnerability to loss arising from the impact of adverse interest rate movements on its Banking Book structure.

8.6 IRRBB and Relation to ICAAP

(1) A Bank must be able to demonstrate to the AFSA that its ICAAP adequately captures its exposure to IRRBB.

(2) In order to meet effectively the obligations it faced under ICAAP which includes the need to address IRRBB exposures, a Bank is required to make a written record of its assessments and stress testing made under this Chapter and rules relating to ICAAP.