Treatment of IRRBB in Latin America Survey results Meeting on Interest Rate Risk in the Banking Book (IRRBB) and the Revised Standardised Approach (RSA) for Credit Risk Sao Paulo, Brazil 27-28 April 2016 Fabiano Gabriel *, fabiano.gabriel@bcb.gov.br * The views expressed in this presentation are those of the presenter and not necessarily those of the FSI, BIS or BCBS. Restricted
Agenda Overview Capital requirements for IRRBB Choices in assessing and measuring IRRBB Reporting, disclosure and supervisory actions Potential impacts of IRRBB in ASBA member countries Restricted 2
Overview Interest Rate Risk in the Banking Book (IRRBB) is a bank s exposure to adverse movements in interest rates When interest rates change, the present value and timing of future cash flows change This in turn changes the underlying value of a bank s assets and liabilities and bank s earnings This risk is inherent to the banking business However high levels of exposure to the IRRBB can pose a significant threat to a bank s capital and/or future earnings This explains the importance of stablishing capital requirements for this type of risk * BCBS, Principles for the Management and Supervision of Interest Rate Risk, July 2004 Restricted 3
Overview Banking book instruments are generally intended to be held to maturity As the changes in market value not necessarily reflected in financial accounts, IRRBB has remained within the Pillar 2 In 2004, the Committee issued the Principles for the management and supervision of IRR (bcbs108) *, stablishing: Standardised shocked scenarios: parallel 200 basis points or 1 st and 99 th percentile of the observed interest rate changes Outlier test: for the identification of banks with material IRRBB exposures, focusing on an economic value metric - Economic value declines > 20% of Capital [Tier 1 + Tier 2] * BCBS, Principles for the Management and Supervision of Interest Rate Risk, July 2004 Restricted 4
Overview After the financial crisis, a consultative document was issued proposing changes for the treatment of IRRBB (d319) * : To help ensure that banks have appropriate capital to cover potential losses from exposures to changes in interest rates To limit incentives for capital arbitrage between the Trading and the Banking Book In discussion, there are two options for the treatment of IRRBB: A standardised Pillar 1 Minimum Capital Requirements, with both economic value and earnings-based measures An enhanced Pillar 2 approach which also includes elements of Pillar 3 Market Discipline * BCBS, Interest Rate Risk in the Banking Book, June 2015 Restricted 5
Overview Design of a survey on the treatment of IRRBB in Latin America A mix of twenty closed and open (qualitative) questions Part 1 Part 2 Part 3 IRRBB Capital Requirements Choices in assessing and measuring IRRBB Reporting, Disclosure and Supervisory Actions Objectives To identify and discuss relevant IRRBB implementation issues for banks in the Americas Restricted 6
Overview Thirteen jurisdictions answered the survey on IRRBB practices Argentina Guatemala Nicaragua Brazil Haiti Paraguay Chile Honduras Peru Dominican Republic Mexico Spain Trinidad and Tobago Results cannot be generalized to all thirty-five ASBA members Restricted 7
Agenda Overview Capital requirements for IRRBB Choices in assessing and measuring IRRBB Reporting, disclosure and supervisory actions Potential impacts of IRRBB in ASBA member countries Restricted 8
Capital requirements for IRRBB Six questions concerning the: Pillar 1 vs. Pillar 2 Approaches Part 1 Metrics required by jurisdiction and adopted by industry - Economic value vs. Earnings based measure Prescribe standardised interest rate shock scenarios Supervisory standards for the management and measurement of IRRBB IRRBB Capital Requirements Definitions and standards for Credit Spread Risk in the Banking Book (CSRBB) Restricted 9
Capital requirements for IRRBB Q.02 - Metric established in Pillar 1 2 No distinction between TB x BB Economic value based measure 1 Earnings based measure More than half of jurisdictions adopt some Pillar 2 approach Restricted 10
Capital requirements for IRRBB Most jurisdictions are aligned to the 2004 principles Restricted 11
Capital requirements for IRRBB Summary of Good Practices - General principles vs. specific treatment for IRRBB - Potential losses under different scenarios - Standardised shocks - Assessment and monitoring of changes in interest income and economic value - Internal limits - Comparison between estimated and current measures - Historical data from main risk factors - Corporate governance Restricted 12
Capital requirements for IRRBB Volatility on interest rates GAP and duration Scenarios Others and NII VaR (Hp = 3 months) Opportunity for improving the way banks are measuring and managing IRRBB Restricted 13
Capital requirements for IRRBB Similarly to previous studies conducted by the BCBS, this demonstrates the early stage of CSRBB's implementation around the globe Restricted 14
Agenda Overview Capital requirements for IRRBB Choices in assessing and measuring IRRBB Reporting, disclosure and supervisory actions Potential impacts of IRRBB in ASBA member countries Restricted 15
Choices in assessing and measuring IRRBB Nine questions regarding the: Prevalent form of IRRBB Part 2 Choices in assessing and measuring IRRBB Interest rate curve used for repricing the cash flows Relative importance of core Non Maturity Deposits Behavioral options - Loans subject to prepayment risk - Deposits subject to redemption risk (early withdraw) Automatic options Basis risk Time horizon for measuring IRRBB Relevance of positions in foreign currency Restricted 16
Choices in assessing and measuring IRRBB Institutions should identify and measure the main components of the IRRBB and choose the most appropriate method to manage this risk Restricted 17
Choices in assessing and measuring IRRBB Another basic concept for computing IRRBB is the choice regarding the interest rate curve used for discounting the notional cash flows Restricted 18
Choices in assessing and measuring IRRBB Non-Maturity Deposits seem relevant, which can strongly influence the final outcomes depending on the modelling assumptions adopted Restricted 19
Choices in assessing and measuring IRRBB Another challenge in measuring IRRBB is the identification and the incorporation of products or positions where the assumed behavioural repricing date differs significantly from the contractual repricing date Restricted 20
Choices in assessing and measuring IRRBB Basis risk and automatic options should also be assessed, due to the uncertainty about the cash flows associated with both. Restricted 21
Choices in assessing and measuring IRRBB Importance of discussing the shorter earnings based measure vs. EV For some jurisdictions the FX positions can be significant Restricted 22
Agenda Overview Capital requirements for IRRBB Choices in assessing and measuring IRRBB Reporting, disclosure and supervisory actions Potential impacts of IRRBB in ASBA member countries Restricted 23
Reporting, disclosure and supervisory actions Five questions covering the: Reporting to Supervisors and Public Disclosure - IRRBB risk management objectives and policies, including relevant assumptions for: NMDs Redemption risk Prepayment risk Regularly conducted onsite and offsite assessments Capital and Non-Capital remedial actions Part 3 Reporting, Disclosure and Supervisory Actions Restricted 24
Reporting, disclosure and supervisory actions Summary of Good Practices - Strategies, processes and methodologies for assessing and measuring IRRBB - Aggregated exposure levels - Definition of internal limits - Amount and average maturity of core Non Maturity Deposits - Assumptions and behavioral options relating to prepayment risk and early withdrawal of deposits - Results of simulations and stress tests Restricted 25
Reporting, disclosure and supervisory actions Summary of Good Practices - Qualitative information about the methodology and measurement systems - Basic assumptions for the NMDs, prepayment and redemption risks - Quantitative information including the increase or decrease in income or economic value, resulting from changes in interest rates - Quarterly publication about exposure levels to IRRBB Restricted 26
Reporting, disclosure and supervisory actions Summary of Good Practices - Trading vs. Banking Book allocation - Risk-based supervision - Risk management policies and practices - Discussion with ALCO - Internal controls - Assessment of limits - Stress tests - Sensitivity analysis - SREP and ICAAP - Monthly offsite monitoring Restricted 27
Reporting, disclosure and supervisory actions 2 3 Outlier test under a Pillar 2 Approach One jurisdiction adopted a ΔEVE >15% Non-capital related actions - Strengthening of management, policies, procedures, controls and assumptions - Adoption of hedging mechanisms Restricted 28
Agenda Overview Capital requirements for IRRBB Choices in assessing and measuring IRRBB Reporting, disclosure and supervisory actions Potential impacts of IRRBB in ASBA member countries Restricted 29
Potential impacts of IRRBB in ASBA member countries Diversity in current bank and supervisory practices How relevant is IRRBB in the overall assessment of risks in the financial system? Different levels of interest rate shock scenarios across jurisdictions Identification of prevalent form of IRRBB Gap risk, non-parallel, optionality and basis risk Choice of the interest rate curve used for discounting cash flows Relevance of NMDs How best to model it and what is the expected impact on the final outcomes? Restricted 30
Potential impacts of IRRBB in ASBA member countries Knowledge of redemption and prepayment rates can be a plus in understanding how banks manage IRRBB Interest rate optionality and basis risk should be assessed Discussion of time horizon for the Earnings based measure Shorter earnings based measure vs. Economic value General principles vs. detailed treatment for the management and measurement of IRRBB Challenge for supervisors in day-to-day supervision Supervision by generalists or risk specialists Restricted 31
Potential impacts of IRRBB in ASBA member countries EVE and NII are the relevant risk measures for IRRBB capital requirements, regardless a Pillar 1 or Pillar 2 approach Opportunity for discussing, establishing and improving: Requirements for: - Reporting to supervisors - Disclosure to stakeholders Regular onsite and offsite procedures Capital and non capital remedial actions outlier test Restricted 32
Thank you for your attention Questions? Restricted 33