Question ID:
2018_4406
Legal Act:
Regulation (EU) No 575/2013 (CRR)
Topic:
Credit risk
Article:
111 and 166
COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations:
Not applicable
Article/Paragraph:
n/a
Disclose name of institution / entity:
No
Type of submitter:
Competent authority
Subject Matter:
Fair value adjustments that arise as a result of applying fair value hedge accounting
Question:

Should fair value adjustments which arise as a result of applying fair value hedge accounting to mitigate interest rate risk be treated under the CRR credit risk framework or under a different risk framework? And if under a different risk framework, which risk framework should that be?

Background on the question:

Banks apply fair value hedge accounting (“FVHA”) to mitigate the interest rate risk associated with their fixed rate mortgages portfolio. Both IAS 39 and IFRS 9 require that fair value adjustments (“FVAs”) are recognized as a result of applying fair value hedge accounting {see IAS 39.89(b) IFRS9. 6.5.8(b)}. The question focuses on the prudential treatment of these FVAs. There are two different views on what the prudential treatment of these FVAs could be: View 1: FVAs should be risk-weighted under the current CRR credit risk framework The current CRR credit risk framework stipulates that the exposure value of an asset item shall be its accounting value. Refer to art. 111 CRR (Standardised Approach) and art. 166 CRR (IRB approach): a. Art. 111 (1) CRR: “The exposure value of an asset item shall be its accounting value remaining after specific credit risk adjustments, additional value adjustments in accordance with Articles 34 and 110 and other own funds reductions related to the asset item have been applied.” b. Art. 166 (1) CRR: “Unless noted otherwise, the exposure value of on-balance sheet exposures shall be the accounting value measured without taking into account any credit risk adjustments made.” The accounting value of the asset measured at amortised cost items that are being hedged via FVHA is the sum of the amortised cost and the FVAs {see IAS 39.89(b) IFRS9. 6.5.8(b)}. As the CRR does not stipulate anywhere in the CRR that it is acceptable to exclude the FVAs, the view is that such exclusion is not allowed. FVAs should then be risk-weighted under the current CRR credit risk framework. View 2: FVAs should not be risk-weighted under the current CRR credit risk framework The FVAs arise as a result of applying FVHA to mitigate interest rate risk. They present the fair value changes due to movements in the interest rates. They do not represent in any way a claim on the borrowers of the hedged exposures. The application of FVHA does therefore not alter the credit risk that is associated with the hedged items. EBA Q&A 2013_101 stipulates that the determining factor for taking into account fair value changes in the current CRR credit risk framework, is whether these “fair value changes are recognised as impairments under IFRS, or as adjustments of a similar nature made under other applicable accounting frameworks that reflect losses related to a deterioration or a worsening of an asset's or an asset portfolio's credit quality.” The FVAs are not a reflection of this. Further, the choice to apply Cash Flow Hedge Accounting (“CFHA”) would lead to different credit risk capital charges than if FVHA would be applied – this is viewed as a strange outcome, given that the underlying credit risks of the fixed rate mortgages portfolio do not change when CFHA or FVHA is applied; the credit risk remains the same in both situations. Further, it the bank’s choice of accounting treatment would influence the RWA for credit risk, this would be an unintended source of RWA variability. Given the fact that these interest rate risks are present in the banking book, it could be argued that these risks should be covered under an IRRBB framework. However, given that banks apply FVHA to mitigate these interest rate risks, one would not expect a capital charge if the hedges are fully effective. The derivatives that are used to mitigate the interest rate risk (i.e. the hedging instruments) will introduce CVA risk which is already covered under CRR. Discussion From an economic/risk perspective, we argue that interest rate risk (of fixed rate mortgages) should be dealt with via a prudential framework that deals with interest rate risk, not one that deals with credit risk. The current CRR framework however is silent on FVHA and/or the FVAs that arise as a result of interest rate movements. The CRR only mentions CFHA in the context of prudential filters (Art. 33 CRR). While we understand that View 2 provides convincing arguments, without more guidance in the CRR on how to deal with FVHA and/or the referred FVAs, the conclusion is drawn that, based on the current CRR credit risk framework, View 1 provides the answer to the question on what the prudential treatment should be of the FVAs. Moreover, we believe this case qualifies for considering a revision to the CRR such that the FVHA elements are being treated under the most applicable risk framework.

Date of submission:
06/12/2018
Published as Rejected Q&A
11/02/2022
Rationale for rejection:

Please note that as part of adjustments to the Single Rulebook Q&A process, agreed by the EBA and the European Commission, it has been decided to reject outstanding questions submitted before 1 January 2020, when the Q&A process was updated as part of the last ESAs Review. In particular, the question that you have submitted has now regrettably been rejected and will not be addressed.

If you believe your question would still benefit from clarification, you are invited to resubmit your question, adapting it to reflect any legislative, regulatory or other relevant developments that may have occurred since the initial date of submission. The EBA will aim to address resubmitted questions as a matter of priority. When considering to resubmit, you are kindly requested to observe the updated admissibility criteria agreed in the context of the adjustment of the Q&A process, available in the Additional background and guidance for asking questions. We hope for your understanding.

For further information please refer to the press release and the updated Q&A page.

Status:
Rejected question
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