• BANK Chapter 8 BANK Chapter 8 Interest rate risk in the banking book

    • BANK 8.1.1 Introduction

      (1) This Chapter sets out the requirements for a banking business firm's policies to identify, measure, evaluate, manage and control or mitigate interest rate risk in the banking book.
      (2) This Chapter also deals with stress-testing the firm's exposure to IRRBB and the relationship between IRRBB and the internal capital adequacy assessment process. IRRBB is a major source of risk for firms that conduct banking activities; this is particularly so if the firm's banking book assets is 15% or more of its total assets.
      (3) Interest rate risk in this Chapter refers to interest rate risk in the banking book. Interest rate risk in the trading book is part of market risk in Chapter 6.
      Amended by QFCRA RM/2015-3 (as from 1st January 2016).

    • BANK 8.1.2 Interest rate risk in the banking book

      (1) Interest rate risk in the banking book or IRRBB is the risk to earnings or capital arising from movement of interest rates.
      (2) 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).

      Examples of sources of IRRBB

      •   risks from underwriting on a firm-commitment basis
      •   risks related to the mismatch of the re-pricing of assets and liabilities, and off-balance-sheet short-term and long-term positions
      •   risks arising from hedging exposure to an interest rate with exposure to another rate that re-prices under different conditions
      •   risks related to uncertainties in the occurrence, timing, pricing or value of transactions
      •   risk that counterparties will redeem fixed-rate products when market rates change.
      Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK 8.1.3 Requirement — interest rate risk in the banking book

      A banking business firm must hold sufficient capital to effectively control or mitigate its IRRBB. The Regulatory Authority may impose a capital requirement based on the firm’s ICAAP if the authority is of the view that the firm’s capital requirement is insufficient to cover its exposure to IRRBB.

      Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK 8.1.4 BANK 8.1.4 Role of governing body — interest rate risk in the banking book

      (1) A banking business firm’s governing body must ensure that the firm’s IRRBB management policy enables the firm to obtain a comprehensive firm-wide view of its IBBRR, taking into account the nature, scale and complexity of its banking book activities.
      (2) The governing body must monitor:
      (a) the nature and level of IRRBB assumed by the firm;
      (b) the firm’s overall IRRBB profile; and
      (c) any changes in market conditions that may affect the firm’s current or prospective risk profile.
      (3) The governing body must ensure that the firm’s senior management establishes and implements an IRRBB management policy that adequately identifies, measures, monitors, reports and controls or mitigates IRRBB.
      Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 8.1.4 Guidance

        1 The governing body of the banking business firm may delegate its role in relation to IRRBB (but not its ultimate responsibility) to a committee of the governing body.
        2 A banking business firm that conducts banking activities or complex principal dealing activities should create a committee to design and implement IRRBB management. This committee may be the same as that described in guidance 1.
        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK 8.1.5 BANK 8.1.5 Policies — management of interest rate risk in the banking book

      A banking business firm’s IRRBB management policy must establish:

      (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; and
      (d) procedures for tracking and reporting exceptions to, and deviations from, limits or policies.
      Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 8.1.5 Guidance

        1 The Regulatory Authority expects a banking business firm to set quantitative and qualitative targets for IRRBB.
        2 For rule 8.1.5(b), internal independent validation should be done by a function that is independent of the function that assumed or incurred the risk.
        3 A firm's IRRBB management policy should provide for the following:
        (a) 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 firm;
        (b) the measurement to be capable of measuring the risk using the earnings approach;
        (c) the measurement to be clearly defined and consistent with the nature and complexity of the structure of the firm's balance sheet;
        (d) balancing cash flows as part of managing IRRBB;
        (e) approval by the governing body, or a committee of the governing body, of any major hedging or risk-management initiatives.
        4 The measurement of IRRBB should include all sources of the risk. The measurement should evaluate the effect of rate changes on earnings or economic value meaningfully and accurately.
        5 Depending on the size and complexity of its banking book, the firm may also need to measure IRRBB using the economic value approach.
        6 Effective risk measurement:
        (a) should flag excessive exposures;
        (b) should evaluate all significant interest rate risk arising from the full range of a banking business firm'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; and
        (d) should ensure accurate and timely data on all aspects of current positions.
        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK 8.1.6 Assumptions and adjustments

      (1) A banking business firm must not use an assumption or adjustment relating to the firm’s exposure to IRRBB unless the assumption or adjustment has been approved by its governing body, or a relevant committee of its governing body.
      (2) The Regulatory Authority may require a firm to seek the authority’s approval before using an assumption or adjustment.
      (3) If required to do so by the authority, the firm must demonstrate how the firm used an assumption or adjustment (whether or not the authority required the assumption or adjustment to be approved).
      Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK 8.1.7 Floating-rate exposures

      A banking business firm 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 firm 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.

      Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK 8.1.8 New products and activities

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

      Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK 8.1.9 BANK 8.1.9 Stress-testing and interest rate risk in the banking book

      (1) A banking business firm must carry out stress-testing of its exposures to IRRBB at intervals appropriate for the nature, scale and complexity of the firm’s business and for its risk profile. A firm with balance-sheet positions in 2 or more currencies must measure its risk exposure in each currency in which 5% or more of its banking book assets or banking book liabilities is denominated.
      (2) The stress-testing:
      (a) must determine the re-pricing gap between the firm’s assets and liabilities, before and after the effect of derivative instruments is taken into consideration; and
      (b) must determine the sensitivity of the firm’s net interest income to a 200-basis-point change in interest rates in relation to the firm’s forecast banking book balance sheet.
      (3) For subrule (2)(b), the Regulatory Authority may, in writing, specify another percentage or number of basis points.

      Guidance

      The risk of changes in the capital values of instruments resulting from changes in interest rates is taken to be market risk.
      (4) The firm must include appropriate scenarios in its stress-testing to measure the firm’s vulnerability to loss under adverse interest rate movements.
      (5) The firm must report to the Regulatory Authority, in the form that the authority directs, the results of its stress-testing.
      (6) In determining the effect of a rate change on its net interest income, the firm must not assume that the rate will become negative.
      Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 8.1.9 Guidance

        1 A banking business firm 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:
        •   a rapid increase in term deposit rates, savings deposit rates and benchmark rates like LIBOR (but with no change in the prime rate); and
        •   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.
        Amended by QFCRA RM/2017-2 (as from 1st April 2017).

    • BANK 8.1.10 Duty to notify authority of decline in value

      A banking business firm must immediately notify the Regulatory Authority if any stress-testing under this Chapter suggests that, as a result of the change in interest rates described in rule 8.1.9(2)(b), the economic value of the firm would decline by more than 20%.

      Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK 8.1.11 BANK 8.1.11 Relation to internal capital adequacy assessment

      A banking business firm must be able to demonstrate to the Regulatory Authority that its ICAAP adequately captures IRRBB.

      Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 8.1.11 Guidance

        A banking business firm'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;
        (c) the size and form of the different interest rate changes to be used for stress-testing;
        (d) whether a dynamic or static approach is used to decide the effect of interest rate changes is used;
        (e) how to treat pipeline transactions (including any related hedging);
        (f) how to aggregate multi-currency interest rate exposures;
        (g) whether or not non-interest-bearing assets and liabilities, capital and reserves are included in the evaluation;
        (h) how to treat current and savings accounts (that is, the maturity attached to exposures without a contractual maturity);
        (i) how to treat 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.
        Derived from QFCRA RM/2014-2 (as from 1st January 2015).