Response to consultation on draft RTS on IRRBB supervisory outlier tests
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● The Bank asks EBA to clarify whether the bucketing methodology is optional and whether institutions may use a more accurate model using actual cash flow schedules and corresponding discount and forward rates. If so, the Bank asks EBA to, explicitly, state the system of bucketing cash flows is an option but not a requirement. If not, the Bank asks EBA how it can reconcile such an inaccurate method with the requirements ex section 4.4 of the concurrently proposed guidelines on the management of IRRBB and CSRBB that require institutions to have a satisfactory internal system for management of IRRBB.
The RTS further requires institutions to apply a floor to shocked rates. The description of this floor does not coincide with the repricing buckets, nor with their midpoints. It, furthermore, is unclear whether the increments in the floors are stepwise or continuous.
● The Bank asks EBA to clarify whether institutions may apply the increments to the floors they must apply to shocked interest rates in a continuous manner. If so, the Bank asks EBA to, explicitly, state institutions may apply the increments in a continuous manner. If not, the Bank asks EBA to clarify how institutions must derive the floor for individual repricing maturity buckets.
Article 5(b) requires institutions to consider he annual ‘market-value’ changes for non-trading book financial instruments accounted at ‘fair value’ with a maturity of more than one year. Institutions can observe ‘market values’ only for traded instruments. ‘Fair value’ is an accounting concept that does not imply a ‘market value’ exists for the instrument.
● The Bank asks EBA to clarify how institutions should determine a market value if the instrument does not trade.
Most accounting regimes require institutions to carry traded and over-the-counter (OTC) derivatives at ‘fair value.’ Institutions use such instruments to hedge interest and credit risk arising from exposures in their banking book. They may carry such instruments at amortised cost and apply hedge accounting to offset the change in the fair value of the hedging instrument. Hedge accounting does not reclassify the hedged instrument as ‘fair value’ instrument. Article 5(b), therefore, leads to spurious measurement of IRRBB for net interest income (NII). To avoid spurious risk measures, institutions must add hedge-accounting rules to their interest rate-risk models for NII. The inclusion of accounting rules transforms an economic measure like NII into an accounting measure like Earnings. In particular the RTS relating to the inclusion of fair-value changes is complex and burdensome as, typically, such changes are the subject of accounting systems and not risk systems.
● The Bank asks EBA to clarify how the focus on accounting principles contributes to effective management of IRRBB from an economic perspective.
Article 5(d) requires institutions to include current commercial margins and other spread components when calculating the changes in net interest income.
● The Bank asks EBA to clarify whether institutions must derive current commercial margins and spreads when there is no trade in the instrument and there is no trade in a close substitute for the instrument.
The banking books of promotional and public banks will hold loans for which there are no deep and liquid markets. Commercial margins and spreads, generally, will reflect the banks’ missions and not the interest rate environment. Both the current and proposed guidelines on the management of IRRBB allow institutions to exclude commercial margins and other spread components from economic value measures.
● The bank suggests EBA to extend the possibility to exclude commercial margins and spreads from the calculation of the supervisory shock scenarios for EVE to those for NII.
The explanatory box following Article 6 remarks with respect to option A, involving metric 1 for the identification of a large decline in NII from the supervisory shock scenario, that option A fails to account for elements other than NII-related elements in the assessment of the sustainability of the business operations.
The Bank remarks that option B, involving metric 2, is highly sensitive to one-off elements in expected NII after costs. These affect the denominator, resulting in a potentially unstable measure. Metric 2, particularly, fails to discern between changes in expenses that can be transient in nature and net interest income. Metric 2 further uses reported FINREP numbers that may reflect accounting or regulatory views rather than ‘economic’ relevance. The Bank further questions whether any measure over a one-year horizon allows for assessment of the sustainability of the business operations. Metric 2, therefore, appears to be more complex and unstable than metric 1 whilst not adding useful information for the assessment of the institution’s sustainability of NII.
● The Bank asks EBA to clarify whether institutions may apply the increments to the floors they must apply to shocked interest rates in a continuous manner.
● The Bank asks EBA to clarify whether ‘interest rates’ referred to in article 3 are ’discount rates’ or ‘spot rates?
● The Bank asks EBA to clarify how institutions must attribute administrative expenses across currencies if EBA chooses to implement metric 2 referred to in article 6. In particular, the Bank asks EBA to clarify how institutions must attribute costs of currency hedges to the relevant currencies.
Respondents are also kindly requested to express whether they find an inclusion of market value changes in the calculation of the NII SOT clear enough.
Information technology allows for institutions to project cash flow schedules using actual maturities and tenures of instruments. The Regulatory Technical Standards (RTS) describe a model that require institutions to assign cash flows to pre-defined maturity and repricing buckets. To implement this, the Bank would have to implement a separate, inaccurate cash flow model for the sole purpose of performing the supervisory shock scenarios.● The Bank asks EBA to clarify whether the bucketing methodology is optional and whether institutions may use a more accurate model using actual cash flow schedules and corresponding discount and forward rates. If so, the Bank asks EBA to, explicitly, state the system of bucketing cash flows is an option but not a requirement. If not, the Bank asks EBA how it can reconcile such an inaccurate method with the requirements ex section 4.4 of the concurrently proposed guidelines on the management of IRRBB and CSRBB that require institutions to have a satisfactory internal system for management of IRRBB.
The RTS further requires institutions to apply a floor to shocked rates. The description of this floor does not coincide with the repricing buckets, nor with their midpoints. It, furthermore, is unclear whether the increments in the floors are stepwise or continuous.
● The Bank asks EBA to clarify whether institutions may apply the increments to the floors they must apply to shocked interest rates in a continuous manner. If so, the Bank asks EBA to, explicitly, state institutions may apply the increments in a continuous manner. If not, the Bank asks EBA to clarify how institutions must derive the floor for individual repricing maturity buckets.
Article 5(b) requires institutions to consider he annual ‘market-value’ changes for non-trading book financial instruments accounted at ‘fair value’ with a maturity of more than one year. Institutions can observe ‘market values’ only for traded instruments. ‘Fair value’ is an accounting concept that does not imply a ‘market value’ exists for the instrument.
● The Bank asks EBA to clarify how institutions should determine a market value if the instrument does not trade.
Most accounting regimes require institutions to carry traded and over-the-counter (OTC) derivatives at ‘fair value.’ Institutions use such instruments to hedge interest and credit risk arising from exposures in their banking book. They may carry such instruments at amortised cost and apply hedge accounting to offset the change in the fair value of the hedging instrument. Hedge accounting does not reclassify the hedged instrument as ‘fair value’ instrument. Article 5(b), therefore, leads to spurious measurement of IRRBB for net interest income (NII). To avoid spurious risk measures, institutions must add hedge-accounting rules to their interest rate-risk models for NII. The inclusion of accounting rules transforms an economic measure like NII into an accounting measure like Earnings. In particular the RTS relating to the inclusion of fair-value changes is complex and burdensome as, typically, such changes are the subject of accounting systems and not risk systems.
● The Bank asks EBA to clarify how the focus on accounting principles contributes to effective management of IRRBB from an economic perspective.
Article 5(d) requires institutions to include current commercial margins and other spread components when calculating the changes in net interest income.
● The Bank asks EBA to clarify whether institutions must derive current commercial margins and spreads when there is no trade in the instrument and there is no trade in a close substitute for the instrument.
The banking books of promotional and public banks will hold loans for which there are no deep and liquid markets. Commercial margins and spreads, generally, will reflect the banks’ missions and not the interest rate environment. Both the current and proposed guidelines on the management of IRRBB allow institutions to exclude commercial margins and other spread components from economic value measures.
● The bank suggests EBA to extend the possibility to exclude commercial margins and spreads from the calculation of the supervisory shock scenarios for EVE to those for NII.
Question 2: Do respondents have any comment related to these two metrics for the specification and the calibration of the test statistic for the large decline in Article 6 for the purpose of NII SOT? Specifically, do respondents find the inclusion of administrative expenses in metric 2 clear enough? Do respondents have any comment on the example on currency aggregation for metric 1 and metric 2?
● The Bank has a strong preference for metric 1.The explanatory box following Article 6 remarks with respect to option A, involving metric 1 for the identification of a large decline in NII from the supervisory shock scenario, that option A fails to account for elements other than NII-related elements in the assessment of the sustainability of the business operations.
The Bank remarks that option B, involving metric 2, is highly sensitive to one-off elements in expected NII after costs. These affect the denominator, resulting in a potentially unstable measure. Metric 2, particularly, fails to discern between changes in expenses that can be transient in nature and net interest income. Metric 2 further uses reported FINREP numbers that may reflect accounting or regulatory views rather than ‘economic’ relevance. The Bank further questions whether any measure over a one-year horizon allows for assessment of the sustainability of the business operations. Metric 2, therefore, appears to be more complex and unstable than metric 1 whilst not adding useful information for the assessment of the institution’s sustainability of NII.
Question 3: Do respondents consider that all the necessary aspects have been covered in the draft regulatory standard? Do respondents find the provisions clear enough or would any additional clarification be needed on any aspect?
● The Bank asks EBA to clarify whether the bucketing methodology is optional and whether institutions may use a more accurate model using actual cash flow schedules and corresponding discount and forward rates.● The Bank asks EBA to clarify whether institutions may apply the increments to the floors they must apply to shocked interest rates in a continuous manner.
● The Bank asks EBA to clarify whether ‘interest rates’ referred to in article 3 are ’discount rates’ or ‘spot rates?
● The Bank asks EBA to clarify how institutions must attribute administrative expenses across currencies if EBA chooses to implement metric 2 referred to in article 6. In particular, the Bank asks EBA to clarify how institutions must attribute costs of currency hedges to the relevant currencies.