Due to different fixed interest rates of assets and liabilities allocated to the banking book, credit institutions are exposed to a risk of changing interest rates on the money and capital markets. This is known as interest rate risk in the banking book or IRBB. The amount of the interest rate risk is significantly influenced by the extent of the maturity transformation between the fixed-interest periods on both the assets and liabilities side. This particularly applies to the retail business with long-term customer loans on the assets side, which are refinanced with variable-rate deposits on the liabilities side.
The interest rate risk in the banking book can be measured and controlled at present value or periodically. 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. Therefore, the focus is on the impact of the change of the interest rate level on the present value of an institution’s assets and liabilities. An increase in interest rates from today’s point of view, for example, reduces the value of the cash flow of an asset transaction (or of the total banking book cash flow with a long-term asset overhang). In the periodic perspective, on the other hand, the direct impact of an interest rate change on the net interest income and thus on the income statement of a credit institution is quantified. 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-bearing capacity and to derive impetus for management.
Due to the high relevance of the interest rate risk in the banking book—especially in the context of a continued low interest rate phase—there are a number of regulatory requirements for the measurement and management of interest rate risks defined by international and national supervisory authorities. The European Banking Authority (EBA) adopted guidelines (EBA/GL/2015/08) and in 2016 the Basel Committee on Banking Supervision (BCBS) published standards (BCBS #368) for the measurement and management of this type of risk in Pillar 2. Elements of both regulations can also be found in the new CRD-V draft of the European Commission and, upon adoption, will be valid immediately for all EU institutions. In addition, the German supervisory authorities have also issued regulations directly related to interest rate risk, such as the MaRisk or the circular 11/2011 (BA) on the standard interest rate shock. Since 2016, the less significant institutions (LSIs), which are supervised by the BaFin in Germany, have had to back part of the assumed risks directly with equity in Pillar 1—within the scope of the supervisory review and evaluation process (LSI-SREP) and the adoption of the general decree on interest rate risk.
Over the next few years as well, a number of new regulatory requirements can be expected. However, the focus of the national and international supervisory authorities will probably be on the harmonization and specification of the various regulations that have already been published or are in consultation.
Sources: BaFin, Bundesbank, BCBS, EBA, zeb.research