Response to consultation on draft RTS on IRRBB standardised approach
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We welcome the exclusion of prepayments on floating rate products as they are generally deemed immaterial. Besides the already small impact on the overall risk metrics in the different scenarios, prepayments on floating rate products are typically independent of the interest environment and therefore do not have a significant impact on the Delta EVE and Delta NII risk metrics which are the key result of this standardized approach.
We generally consider the modelling of non-maturing deposits in the standardized approach using "core" and "non-core" volumes, which is common in many banks, to be a reasonable choice for smaller institutions as well. This enables banks to take into account, within a clearly defined framework, the bank- and customer-specific characteristics of the deposits in the standardized approach. However, we consider the additional subdivision into "stable" and "non-stable" to be redundant, as the approaches are not clearly distinguishable and, moreover, interest is mixed with liquidity considerations. Furthermore, it is confusing that the definition of the stable portion refers to "the current level of interest rates" (p. 18), but "upward and downward movements" of the last ten years are to be considered in the determination (Art. 7, p. 23).
Moreover, the exclusion of wholesale NMDs from financial customers is not consistent with the Basel standard.
Our members find the determination and application of a conditional prepayment rate as described in Article 8 operationally implementable. However, we do not agree with the definition of the exception/threshold in Art. 8 para. 2. Rather than defining a threshold based on 2% the total of fixed rate loans we suggest a threshold based on the impact such options will have on the results. In the current case, a bank that allows a full loan repayment for 1,9% of their positions referred to in Art. 2(2) would not have to model their prepayment whereas a bank that allows a 5% repayment for 2% of their positions would have to include the impact. A determination of the materiality based on the percentage of possible prepayments is deemed more adequate.
Throughout the document, it should be made clear that the estimation must be applied consistently over time (cf. Art. 9) and it is not the estimator itself that has to be consistent (cf. p. 9 vs. p. 26).
Yes, the approach is clear. However, we propose to include a materiality threshold under which such instruments must be included.
Only few small and medium-size banks without a trading book have the capacity to implement such an approach using a full revaluation. The current definition of products that fall underneath is too wide, making it impossible for such banks to implement if not at the expense of a disproportionate effort. A materiality threshold and further simplification are needed (such as in Art. 23(2) for the simplified standardized approach).
Examples of products that currently fall under the definition:
Floating rate products with an implicit floor of 0% either on the total costumer rate or the reference rate
Wholesale fixed term deposits with an early redemption right under Article 9(3)
Implicit 0% Floors on Non-maturing Retail deposits
In addition, we ask for clarifications concerning the empirical information on which the assumption of the 25% increase is based.
The approach is comprehensive. However, it will be challenging to collect the relevant data and operationally challenging to perform this calculation. Therefore, we emphasize that banks should not be required to calculate the approach in addition to the internal modelling approaches, but only if their internal model is deemed not satisfactory.
Especially the cash flow slotting according to shock scenarios is far too complex and the economic rationale is not clear since the core component is the part of the NMDs that “is unlikely to reprice even under significant changes in the interest rate environment”.
Furthermore, we do not see the rationale behind the structure of the reference term time buckets and we believe that a more detailed elaboration is needed on the economic background on why this is deemed adequate.
Overall, we believe that consistency in the process makes sense. However, we further suggest including a threshold under which banks are eligible to disregard such effects in the standardized approach to ensure that such an effort-intensive calculation is only performed if the underlying risk is actually material for the bank.
Furthermore, if the narrow definition of NII prevails in the regulatory outlier test, we additionally point out that this must also be considered in the definition of the standardised models.
In this regard much depends on the size and complexity of the institutions. While it could make sense for larger and more complex institutions, for the smaller ones who are likely to be the main users of a standardized model it is far too complex and not relevant. We suggest including a threshold under which banks are eligible to disregard such effects in the standardized approach to ensure that such an effort-intensive calculation is only performed if the underlying risk is actually material for the bank.
On the EVE approach
The simplifications for small and non-complex institutes are not sufficient to support implementation by simpler retail banks. While we welcome the simplifications regarding automatic options (Art. 23(2), see comments under Question 5), the predefined volumes divert significantly from the average retail bank. This can be applied for the calculation of a conservative risk metric, however, as elaborated above, this approach cannot be used for the comparison to internal models or for other benchmark activities.
On the NII approach
We appreciate the effort to simplify the NII Standardized Approach for small, non-complex institutions. However, the requirements are still rather complex (data requirements, options, margins, basis risk, fair value changes).
In line with the EVE simplified Standardized Approach, the treatment of NMDs does not reflect the actual behaviour for local and small banks where deposits are one of their core competences. Hence, we generally suggest allowing more flexibility and change the wording on the simplified standardized approach from “shall” to “may” to allow for implementation of a more adequate approach.
We further suggest to only consider the reinvestment of the principal in line with the constant balance sheet definition as the priority and focus on the delta NII in a narrow sense. This will simplify the currently very complex calculation and make the implementation much more feasible. It is particularly relevant as the approach should also be implementable for banks where the interest rate risk management was deemed inadequate.
It should be made clear that, regarding the empirical determination of commercial margins, no breakdown into counterparties is required.
We would like to point out that inconsistencies may arise if internal systems were used for one perspective (EVE/NII) and the (simplified) standardised methodology was mandatory for the respective other perspective. For instance, in the case of NMDs, different cash flows could be modelled in the two perspectives: one cash flow that appropriately maps the institution’s planned interest rate adjustment policy and one cash flow constructed according to prudential regulations. In this case, different control signals could arise, not only from the differences between the EVE and NII methods but also from the diverging cash flows. This would significantly complicate the interpretation of the results. Solutions to this problem should also be explored. One option would be the simultaneous application of the (simplified) standardised methodology in both perspectives – even if a satisfactory internal system exists for one of them.
Moreover, we would like to emphasize some of our comments under the previous questions.
The current standardized model is hardly implementable for small and medium non-complex banks due to high requirements and the complexity of the approach (in particular regarding Art. 12)
The standardized approaches and even more so the simplified approaches – given the strong deviation from adequate internal risk management, pricing and steering – do not reflect the actual economic risk and can only be used as a conservative interim model that should not be used as a benchmark or for other (supervisory) comparative purposes. This should be pointed out explicitly in the RTS. We emphasize that banks should not be required to calculate the approach (e.g. for the purposes mentioned above) unless their internal model is deemed not satisfactory.
All the additional add-ons for basis risk, margin risk, automatic options and prepayment options are too complex and need simplifications as well as (relevant) materiality thresholds.
We generally suggest simplifying the overall approaches with a model that focuses solely on the delta NII in a narrow sense to allow a much more implementable and adequate calculation
We would also reiterate the following:
p. 18, (15), p. 23, Art. 4 – small and non-complex institutions cannot model pass through rates because of price effects, as pricing effects can only be mapped by means of complex derivatives (for example, a deposit of € 100 the interest rate of which is determined by passing through 70 % of a current market interest rate to the customer, is no longer worth € 100 in the event of an interest rate adjustment. This problem can be circumvented using moving averages).
p. 19, 2(b) – Please clarify which instruments are subsumed by “non-interest derivatives … referencing an interest rate”.
p. 19 Art. 3 (1) – materiality definition per currency?
p. 20, Definition “increase of short-term interest rates” for purpose of Art. 23 is missing.
Question 1: What is the materiality of prepayments for floating rate instruments and what are the underlying factors? Would you prefer the inclusion of a requirement in Article 6 for institutions to estimate prepayments for these instruments?
Please refer to the attached paper for further details.We welcome the exclusion of prepayments on floating rate products as they are generally deemed immaterial. Besides the already small impact on the overall risk metrics in the different scenarios, prepayments on floating rate products are typically independent of the interest environment and therefore do not have a significant impact on the Delta EVE and Delta NII risk metrics which are the key result of this standardized approach.
Question 2: Do respondents find that the required determination of stable/non-stable deposits, and core/non-core deposits as described in Article 7 is reflective of the risks and operationally implementable? In case of any unintended consequence or undesirable effect on certain business models or specific activities, please kindly provide concrete examples.
Please refer to the attached paper for further details.We generally consider the modelling of non-maturing deposits in the standardized approach using "core" and "non-core" volumes, which is common in many banks, to be a reasonable choice for smaller institutions as well. This enables banks to take into account, within a clearly defined framework, the bank- and customer-specific characteristics of the deposits in the standardized approach. However, we consider the additional subdivision into "stable" and "non-stable" to be redundant, as the approaches are not clearly distinguishable and, moreover, interest is mixed with liquidity considerations. Furthermore, it is confusing that the definition of the stable portion refers to "the current level of interest rates" (p. 18), but "upward and downward movements" of the last ten years are to be considered in the determination (Art. 7, p. 23).
Moreover, the exclusion of wholesale NMDs from financial customers is not consistent with the Basel standard.
Question 3: Do respondents find that the required determination and application of a conditional prepayment rate and term deposit redemption rate as described in Article 8 and 9 is reflective of the risks and operationally implementable? In case of any unintended consequence or undesirable effect on certain business models or specific activities, please kindly provide concrete examples.
Please refer to the attached paper for further details.Our members find the determination and application of a conditional prepayment rate as described in Article 8 operationally implementable. However, we do not agree with the definition of the exception/threshold in Art. 8 para. 2. Rather than defining a threshold based on 2% the total of fixed rate loans we suggest a threshold based on the impact such options will have on the results. In the current case, a bank that allows a full loan repayment for 1,9% of their positions referred to in Art. 2(2) would not have to model their prepayment whereas a bank that allows a 5% repayment for 2% of their positions would have to include the impact. A determination of the materiality based on the percentage of possible prepayments is deemed more adequate.
Throughout the document, it should be made clear that the estimation must be applied consistently over time (cf. Art. 9) and it is not the estimator itself that has to be consistent (cf. p. 9 vs. p. 26).
Question 4: Is the treatment of fixed rate loan commitments to retail counterparties clear and are there other instruments with retail counterparties where a behavioural approach to optionality should be taken?
Please refer to the attached paper for further details.Yes, the approach is clear. However, we propose to include a materiality threshold under which such instruments must be included.
Question 5: Do respondents find that the required determination of the impact of a 25% increase in implicit volatility as described in Article 12 is operationally implementable?
Please refer to the attached paper for further details.Only few small and medium-size banks without a trading book have the capacity to implement such an approach using a full revaluation. The current definition of products that fall underneath is too wide, making it impossible for such banks to implement if not at the expense of a disproportionate effort. A materiality threshold and further simplification are needed (such as in Art. 23(2) for the simplified standardized approach).
Examples of products that currently fall under the definition:
Floating rate products with an implicit floor of 0% either on the total costumer rate or the reference rate
Wholesale fixed term deposits with an early redemption right under Article 9(3)
Implicit 0% Floors on Non-maturing Retail deposits
In addition, we ask for clarifications concerning the empirical information on which the assumption of the 25% increase is based.
Question 6: Do respondents find that the required slotting of repricing cash flows in accordance with the second dimension of original maturity/reference term as described in Article 13 is operationally implementable?
Please refer to the attached paper for further details.The approach is comprehensive. However, it will be challenging to collect the relevant data and operationally challenging to perform this calculation. Therefore, we emphasize that banks should not be required to calculate the approach in addition to the internal modelling approaches, but only if their internal model is deemed not satisfactory.
Especially the cash flow slotting according to shock scenarios is far too complex and the economic rationale is not clear since the core component is the part of the NMDs that “is unlikely to reprice even under significant changes in the interest rate environment”.
Furthermore, we do not see the rationale behind the structure of the reference term time buckets and we believe that a more detailed elaboration is needed on the economic background on why this is deemed adequate.
Question 7: Do respondents find it practical how the determination of several components of the NII calculation, with in particular the fair value component of Article 20 and the fair value component of automatic options of Article 15, is generally based on the processes used for the EVE calculation (in particular Article 16 and Article 12)?
Please refer to the attached paper for further details.Overall, we believe that consistency in the process makes sense. However, we further suggest including a threshold under which banks are eligible to disregard such effects in the standardized approach to ensure that such an effort-intensive calculation is only performed if the underlying risk is actually material for the bank.
Furthermore, if the narrow definition of NII prevails in the regulatory outlier test, we additionally point out that this must also be considered in the definition of the standardised models.
Question 8: Do respondents find that the calculation of the net interest income add-on for basis risk is reflective of the risk and operationally implementable
Please refer to the attached paper for further details.In this regard much depends on the size and complexity of the institutions. While it could make sense for larger and more complex institutions, for the smaller ones who are likely to be the main users of a standardized model it is far too complex and not relevant. We suggest including a threshold under which banks are eligible to disregard such effects in the standardized approach to ensure that such an effort-intensive calculation is only performed if the underlying risk is actually material for the bank.
Question 9: Do respondents find that the adjustments in the Simplified Standardised Approach as set out in Article 23 and 24 are operationally implementable, and do they find that any other simplification would be appropriate?
Please refer to the attached paper for further details.On the EVE approach
The simplifications for small and non-complex institutes are not sufficient to support implementation by simpler retail banks. While we welcome the simplifications regarding automatic options (Art. 23(2), see comments under Question 5), the predefined volumes divert significantly from the average retail bank. This can be applied for the calculation of a conservative risk metric, however, as elaborated above, this approach cannot be used for the comparison to internal models or for other benchmark activities.
On the NII approach
We appreciate the effort to simplify the NII Standardized Approach for small, non-complex institutions. However, the requirements are still rather complex (data requirements, options, margins, basis risk, fair value changes).
In line with the EVE simplified Standardized Approach, the treatment of NMDs does not reflect the actual behaviour for local and small banks where deposits are one of their core competences. Hence, we generally suggest allowing more flexibility and change the wording on the simplified standardized approach from “shall” to “may” to allow for implementation of a more adequate approach.
We further suggest to only consider the reinvestment of the principal in line with the constant balance sheet definition as the priority and focus on the delta NII in a narrow sense. This will simplify the currently very complex calculation and make the implementation much more feasible. It is particularly relevant as the approach should also be implementable for banks where the interest rate risk management was deemed inadequate.
It should be made clear that, regarding the empirical determination of commercial margins, no breakdown into counterparties is required.
Question 10: Do respondents find that all the necessary aspects are covered and the steps and assumptions for the evaluation of EVE and NII as laid out in the standardised approach and simplified standardised approach clear enough and operationally implementable?
Please refer to the attached paper for further details.We would like to point out that inconsistencies may arise if internal systems were used for one perspective (EVE/NII) and the (simplified) standardised methodology was mandatory for the respective other perspective. For instance, in the case of NMDs, different cash flows could be modelled in the two perspectives: one cash flow that appropriately maps the institution’s planned interest rate adjustment policy and one cash flow constructed according to prudential regulations. In this case, different control signals could arise, not only from the differences between the EVE and NII methods but also from the diverging cash flows. This would significantly complicate the interpretation of the results. Solutions to this problem should also be explored. One option would be the simultaneous application of the (simplified) standardised methodology in both perspectives – even if a satisfactory internal system exists for one of them.
Moreover, we would like to emphasize some of our comments under the previous questions.
The current standardized model is hardly implementable for small and medium non-complex banks due to high requirements and the complexity of the approach (in particular regarding Art. 12)
The standardized approaches and even more so the simplified approaches – given the strong deviation from adequate internal risk management, pricing and steering – do not reflect the actual economic risk and can only be used as a conservative interim model that should not be used as a benchmark or for other (supervisory) comparative purposes. This should be pointed out explicitly in the RTS. We emphasize that banks should not be required to calculate the approach (e.g. for the purposes mentioned above) unless their internal model is deemed not satisfactory.
All the additional add-ons for basis risk, margin risk, automatic options and prepayment options are too complex and need simplifications as well as (relevant) materiality thresholds.
We generally suggest simplifying the overall approaches with a model that focuses solely on the delta NII in a narrow sense to allow a much more implementable and adequate calculation
We would also reiterate the following:
p. 18, (15), p. 23, Art. 4 – small and non-complex institutions cannot model pass through rates because of price effects, as pricing effects can only be mapped by means of complex derivatives (for example, a deposit of € 100 the interest rate of which is determined by passing through 70 % of a current market interest rate to the customer, is no longer worth € 100 in the event of an interest rate adjustment. This problem can be circumvented using moving averages).
p. 19, 2(b) – Please clarify which instruments are subsumed by “non-interest derivatives … referencing an interest rate”.
p. 19 Art. 3 (1) – materiality definition per currency?
p. 20, Definition “increase of short-term interest rates” for purpose of Art. 23 is missing.