Response to consultation on Guidelines on technical aspects of the management of interest rate risk
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Indeed, the concept of “prospective” can in our opinion only be used within the context of the earnings which can be considered in a more dynamic way via the look-through method.
Furthermore this definition should also elaborate on the difference between the impact of interest rates on interest rate sensitive instruments (IRRBB senso stricto) and on business risk (to be included in IRRBB senso lato). Indeed, we would like to stress that the pressure on business margins is not always due to the evolution of interest rates. It may also be caused by increased competition on markets. – which is not to be considered as IRRBB senso lato. Please clarify.
• The Guidelines also cover Credit Spreads Risk, but there is little clarification provided on the instruments that are in scope. It is unclear whether only assets or both assets and liabilities are in scope as well as to which positions it applies (e.g. only for positions at fair value), nor is it clear what is meant with credit risk in this definition and how should this be distinguished.
Febelfin would like to suggest to introduce a link to the IFRS9 business model (HTC/HTS) and a reference to the impact on OCI (capital base).
EBA’s definition of CSRBB, is also not sufficiently clear as it does not provide a clear distinction between credit spread risk and credit margin (risk) In line with the EBF view the scope should be restricted to liquid banking book assets for which a change in credit spread has a direct impact on capital ratios, if this is not yet included in the bank's ICAAP or provisioning process.
• According to the EBA definitions, a constant balance sheet can only be obtained by assuming like-for-like replacements of assets and liabilities as they run off. This is a too strict definition as a constant balance sheet could also be defined with a constant duration approach, rather than a like-for-like replacement (which can also cause for artificial IRRBB exposures).
The introduction of “risk appetite” within the capital assessment process is confusing. Most Belgian banks would seek to have a capital allocation process that is exclusively linked to loss risk.
“Risk appetite” is more aligned to the level of variability risk, be it in terms of Economic Value or in Net Interest Income, that an institution is prepared to accept. The capital section of this paper looks more like a buffer allocation process, rather than a capital process linked to loss risk.
This section is not giving clear guidance, but instead is giving further opportunities for our local regulators to allocate buffers against specific items. As there is not a universal capital allocation process for IRRBB, the introduction of “risk appetite” will add further differences on how banks capitalise this risk.
The “risk appetite” could be viewed as banks internal appetite for IRRBB variability, so its inclusion within the capital assessment process leads to a conclusion that it is the IRRBB variability what the EBA is seeking to capitalise.
Please see detailed comments below.
- Paragraph 23: ‘Institutions should demonstrate that their internal capital is commensurate with the level of IRRBB, taking into account the impact on internal capital of potential “changes” in the economic value and future earnings resulting from changes in interest rates. Institutions are not expected to double count their internal capital for EV and earning measures’.
It is not sufficiently clear how “potential changes” in both elements, economic value and future earnings, should be taken into account in determining the amount of capital that needs to be held for IRRBB. Should both elements be included in an IRRBB capital model or does this guideline intend to say that both elements should be included in the ICAAP, but not necessarily both of them in an IRRBB capital model?
- Paragraphs 23, 24 (a) ,26 (e) 30(b) and 31
The above paragraphs suggest that banks should hold capital against variability risks. These are not real losses, but merely an opportunity loss. The wording of paragraphs n°30(b) and n°26 should be symmetrical. A capital charge should only be required when the bank is exposed to a risk of loss as opposed to a variability risk. Any capital requirement due to potential reduced earnings should be excluded from this guideline. The objective of the IRRBB Guideline is to prevent banks from losses and not from reduced earnings (Paragraph 31).
- Paragraph 26a)
The following statement “The size and tenor of internal limits on IRRBB exposures, and whether these limits are reached at the point of capital calculation…” needs to be clarified as to what it means for the calculation of capital and how this feeds into the capital adequacy assessment of IRRBB.
As far as its regards para 39, we wonder whether consolidated entities will be required to follow the group policy, even when the business model/clients’ profile of these entities differ thoroughly from those of the parent company.
If a duration of 0Y is intended with this phrasing, Febelfin believes that this metric is little valuable as a duration of 0Y for non-maturity deposits is just too unrealistic.
Febelfin is more in favor of an economic metric that measures the sensitivity and uncertainties of behavioural assumptions.
Individual institutions are best placed to set up a useful metric aligned to the nature of their specific portfolio of products.
In our opinion, the current proposal is conservative. This in combination with the set of conservative principles on retail deposits is very punishing for any retail bank and especially for the Belgian retail model as a whole.
We believe that we are currently in an exceptional interest rate environment that is already overly determined by the actions of Central Banks.
In light of that, a further sharp decrease of short and long term interest rates to such extreme negative levels seems very unlikely.
Question 1: Are the definitions sufficiently clear? If not, please provide concrete suggestions and justify your answer.
• EBA’s definition of IRRBB should be reworded, we suggest to delete “or prospective” as this notion is not compatible with the economic value which is only relevant within a static approach.Indeed, the concept of “prospective” can in our opinion only be used within the context of the earnings which can be considered in a more dynamic way via the look-through method.
Furthermore this definition should also elaborate on the difference between the impact of interest rates on interest rate sensitive instruments (IRRBB senso stricto) and on business risk (to be included in IRRBB senso lato). Indeed, we would like to stress that the pressure on business margins is not always due to the evolution of interest rates. It may also be caused by increased competition on markets. – which is not to be considered as IRRBB senso lato. Please clarify.
• The Guidelines also cover Credit Spreads Risk, but there is little clarification provided on the instruments that are in scope. It is unclear whether only assets or both assets and liabilities are in scope as well as to which positions it applies (e.g. only for positions at fair value), nor is it clear what is meant with credit risk in this definition and how should this be distinguished.
Febelfin would like to suggest to introduce a link to the IFRS9 business model (HTC/HTS) and a reference to the impact on OCI (capital base).
EBA’s definition of CSRBB, is also not sufficiently clear as it does not provide a clear distinction between credit spread risk and credit margin (risk) In line with the EBF view the scope should be restricted to liquid banking book assets for which a change in credit spread has a direct impact on capital ratios, if this is not yet included in the bank's ICAAP or provisioning process.
• According to the EBA definitions, a constant balance sheet can only be obtained by assuming like-for-like replacements of assets and liabilities as they run off. This is a too strict definition as a constant balance sheet could also be defined with a constant duration approach, rather than a like-for-like replacement (which can also cause for artificial IRRBB exposures).
Question 4: Are the guidelines in section 4.2. regarding the capital identification, calculation, and allocation sufficiently clear? If not, please provide concrete suggestions and justify your answer.
The guidelines are not clear.The introduction of “risk appetite” within the capital assessment process is confusing. Most Belgian banks would seek to have a capital allocation process that is exclusively linked to loss risk.
“Risk appetite” is more aligned to the level of variability risk, be it in terms of Economic Value or in Net Interest Income, that an institution is prepared to accept. The capital section of this paper looks more like a buffer allocation process, rather than a capital process linked to loss risk.
This section is not giving clear guidance, but instead is giving further opportunities for our local regulators to allocate buffers against specific items. As there is not a universal capital allocation process for IRRBB, the introduction of “risk appetite” will add further differences on how banks capitalise this risk.
The “risk appetite” could be viewed as banks internal appetite for IRRBB variability, so its inclusion within the capital assessment process leads to a conclusion that it is the IRRBB variability what the EBA is seeking to capitalise.
Please see detailed comments below.
- Paragraph 23: ‘Institutions should demonstrate that their internal capital is commensurate with the level of IRRBB, taking into account the impact on internal capital of potential “changes” in the economic value and future earnings resulting from changes in interest rates. Institutions are not expected to double count their internal capital for EV and earning measures’.
It is not sufficiently clear how “potential changes” in both elements, economic value and future earnings, should be taken into account in determining the amount of capital that needs to be held for IRRBB. Should both elements be included in an IRRBB capital model or does this guideline intend to say that both elements should be included in the ICAAP, but not necessarily both of them in an IRRBB capital model?
- Paragraphs 23, 24 (a) ,26 (e) 30(b) and 31
The above paragraphs suggest that banks should hold capital against variability risks. These are not real losses, but merely an opportunity loss. The wording of paragraphs n°30(b) and n°26 should be symmetrical. A capital charge should only be required when the bank is exposed to a risk of loss as opposed to a variability risk. Any capital requirement due to potential reduced earnings should be excluded from this guideline. The objective of the IRRBB Guideline is to prevent banks from losses and not from reduced earnings (Paragraph 31).
- Paragraph 26a)
The following statement “The size and tenor of internal limits on IRRBB exposures, and whether these limits are reached at the point of capital calculation…” needs to be clarified as to what it means for the calculation of capital and how this feeds into the capital adequacy assessment of IRRBB.
Question 6: Are the guidelines in section 4.3. regarding the governance sufficiently clear? If not, please provide concrete suggestions and justify your answer.
The Guidelines should in our opinion only apply at conso and solo level (not at subconso level)As far as its regards para 39, we wonder whether consolidated entities will be required to follow the group policy, even when the business model/clients’ profile of these entities differ thoroughly from those of the parent company.
Question 8: Do you consider the comparison between EV metrics calculated using contractual terms for NMDs with the EV metrics calculated with behavioural modelled assumptions sensible and practical? Please justify your answer.
Firstly, contractual terms for non-maturity deposits are contradictory to the nature of these products.If a duration of 0Y is intended with this phrasing, Febelfin believes that this metric is little valuable as a duration of 0Y for non-maturity deposits is just too unrealistic.
Febelfin is more in favor of an economic metric that measures the sensitivity and uncertainties of behavioural assumptions.
Individual institutions are best placed to set up a useful metric aligned to the nature of their specific portfolio of products.
Question 12: Which treatment of commercial margins cash flows do you consider conceptually most correct in EV metric, when discounting with risk free rate curve: a) including commercial margins cash flows or b) excluding commercial margins cash flows? Please justify your answer.
Conceptually, we believe that commercial margins should be excluded from cash flows when discounting with a risk free rate curve. Commercial margins should only be included in case of an “economic” discounting approach. Given the technical constraints banks might face to distinct these commercial margins, banks should freely have the option to choose one of both reporting views, ideally in line with their internal IRRBB management approach.Question 14: Do you consider the level of the proposed linear lower bound as described in paragraph 113 (k) appropriate? If not, please provide concrete suggestions and justify your answer.
The level of the linear lower bound seems arbitrarily chosen and we would like to know what is the economic reasoning behind this.In our opinion, the current proposal is conservative. This in combination with the set of conservative principles on retail deposits is very punishing for any retail bank and especially for the Belgian retail model as a whole.
We believe that we are currently in an exceptional interest rate environment that is already overly determined by the actions of Central Banks.
In light of that, a further sharp decrease of short and long term interest rates to such extreme negative levels seems very unlikely.