A. IRRBB - Management Framework & Governance

1. This section of the BPG sets out the standards, guidance and norms required to fulfil the regulatory requirements in respect of the Risk management framework and governance addressing IRRBB, as specified in Section 8.1 of Chapter 8 of BBR. These elements convey the supervisory expectations of the AFSA regarding the framework for management of IRRBB and its governance. The AFSA will use these standards, norms and key elements specified here to assess compliance with BBR Rules on management of its IRRBB exposures.

2. A Bank’s IRRBB management policy is expected to address the following:

(a) effective systems for the accurate and timely identification, measurement, evaluation, management and control or mitigation of IRRBB, and reporting to the firm’s governing body and senior management;

(b) regular review, and independent internal or external validation, of any model used by the firm to manage IRRBB (including review of significant assumptions);

(c) prudent and appropriate limits that are consistent with the firm’s risk tolerance, risk profile and capital;

(d) procedures for tracking and reporting exceptions and deviations from limits;

(e) the use of the output of the risk measurement under the policy to report the level of that risk to the senior management and governing body of the Bank;

(f) the measurement to be capable of measuring the risk using the earnings approach;

(g) the measurement to be clearly defined and consistent with the nature and complexity of the structure of the firm’s balance sheet;

(h) provide for balancing cash flows as part of managing IRRBB; and

(i) approval by the governing body, or a committee of the governing body, of any major hedging or risk-management initiatives.

B. IRRBB Management Processes and standards

5. This section of the BPG sets out the standards, guidance, and best practices required to fulfil the regulatory requirements in respect of the IRRBB management processes, specified in Section 8.3 of Chapter 8 of BBR. The AFSA will use these standards, norms and key elements to assess compliance with BBR Rules on IRRBB management processes and procedures and the effectiveness of such processes. The risk of changes in the capital values of instruments resulting from changes in interest rates is taken to be Market Risk.

6. The AFSA expects a Bank to set quantitative and qualitative limits and targets for managing its exposure to IRRBB. The Bank should establish and enforce operating limits and other practices that maintain IRRBB exposures within levels consistent with their internal policies and that accord with their approach to measuring the risk. In particular, Banks should set a limit on the extent to which floating rate exposures are funded by fixed rate sources and vice versa to limit the risk. In floating rate lending, Banks are expected to limit the extent to which they run any basis risk that may arise if lending and funding are not based on precisely the same market interest rate (e.g. LIBOR). The AFSA also expects the internal independent validation to be done by a function that is independent of the function that assumed or incurred the risk.

7. The systems and processes for the measurement of IRRBB as required by the BBR Rule 8.1 (4) (

c) should encompass all material drivers of IRRBB. The measurement should evaluate the effect of rate changes on earnings or economic value meaningfully and accurately within the context and complexity of the Bank’s business activities. Depending on the size and complexity of its banking book, the Bank may also need to measure IRRBB using the economic value approach.

8. The IRRBB risk measurement systems and methodologies employed by a Bank to meet the requirements under BBR Rule 8.1 (4):

(a) should flag excessive exposures;

(b) should evaluate interest rate risk arising from the full range of the Bank’s assets, liabilities and off-balance-sheet positions, across both trading and banking books;

(c) should ensure that an integrated view of IRRBB across products and business lines is available to management, particularly when different measurement systems and methods are used across different business lines;

(d) should ensure accurate and timely data on all aspects of current positions.

(e) employ generally accepted financial models and ways of measuring risk; and

(f) ensure accurate and timely data on all aspects related to current positions.

C. Stress Testing & IRRBB

9. This section of the BPG provides useful guidance on the supervisory expectations of the AFSA in respect of the stress testing of exposure to IRRBB. In order to demonstrate full compliance with the stress testing requirements mandated in the Rules in section 8.4 of BBR, Banks are expected to comply with the standards, norms and guidance provided in this section, in an effective manner.

10. For the purposes of BBR Rule 8.4, a Bank should consider the standards for stress testing recommended in the paper published by the Basel Committee for Banking Supervision – Principles for management and supervision of interest rate risk – in July 2004. In particular, a Bank should include the technical specifications of a standardised interest rate shock detailed in Annex 3 of that paper as part of its systems for measurement of interest rate risk in its Banking Book.

11. A Bank should measure its vulnerability to loss in stressed market conditions, including market conditions in which significant assumptions are no longer met, and consider the results of that measurement when establishing and reviewing its IRRBB management policy. Stress scenarios for this exercise should include:

(a) historical scenarios such as the Asian crisis in the late 1990s;

(b) changes in the general level of interest rates (for example, changes in yields of 100 basis points or more in 1 year);

(c) changes in the relationships between significant market rates (basis risk), such as:

i) a rapid increase in term deposit rates, savings deposit rates and benchmark rates like LIBOR (but with no change in the prime rate); and

ii) a drop in the prime rate (but with no change in term deposit rates, savings deposit rates and benchmark rates);

(d) changes in interest rates in separate time bands to different relative levels (that is, yield curve risk or changes in how interest rates vary over time);

(e) changes in the liquidity of financial markets;

(f) changes in the volatility of market rates; and

(g) changes in business assumptions and parameters such as the correlation between 2 currencies. In particular, changes in assumptions used for illiquid instruments and instruments with uncertain contractual maturities help understanding of a Bank’s risk profile.

12. Chapter 8 of BBR dealing with IRRBB and its management does not impose an explicit Capital Requirement relating to IRRBB. Consistent with the approach prescribed under Basel III framework, the AFSA intends to address IRRBB as part of its Pillar II supervisory process. So, the AFSA expects a Bank to diligently carry out the evaluations and stress tests mandated in Chapter 8 of BBR and include the results as part of its annual ICAAP.

13. Following a Supervisory review of the annual ICAAP submission, the AFSA may impose an Individual Capital Requirement (ICR) on the Bank involved, if it is of the view that the Bank’s minimum Capital Requirement as defined in Chapter 4 of BBR is insufficient to address adequately all its risks, and in particular its exposure to IRRBB.

14. In order to comply with the BBR Rule 8.6 in an effective manner, a Bank’s approach to evaluating and managing IRRBB as part of its ICAAP should include the following:

(a) the internal definition of, and the boundary between, Banking Book and Trading Book;

(b) a definition of economic value showing that it is consistent with the method used to value assets and liabilities (e.g. discounted cashflows);

(c) the size and form of the different interest rate shocks to be used for stress- testing;

(d) the use of a dynamic or static approach in the application of interest rate shocks;

(e) the treatment of commonly called “pipeline transactions” (including any related hedging);

(f) the aggregation of multi-currency interest rate exposures;

(g) the inclusion (or not) of non-interest-bearing assets and liabilities (including capital and reserves)

(h) the treatment of current and savings accounts (that is, the maturity attached to exposures without a contractual maturity);

(i) the treatment of fixed-rate assets or liabilities, if customers have a right to repay or withdraw early;

(j) the extent to which sensitivities to small changes can be scaled up linearly without significant loss of accuracy (covering both convexity generally and the nonlinearity of pay-off associated with explicit option products);

(k) the degree of granularity employed (for example, offsets within a time band or zone);

(l) whether all future cash flows or only principal balances are included.