Response to consultation on draft RTS on IRRBB standardised approach
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§3. The Committee noted the industry’s feedback on the feasibility of a Pillar 1 approach to IRRBB, in particular the complexities involved in formulating a standardised measure of IRRBB which would be both sufficiently accurate and risk-sensitive to allow it to act as a means of setting regulatory capital requirements. The Committee concludes that the heterogeneous nature of IRRBB would be more appropriately captured in Pillar 2.
In that context, a Standardized (or Simplified) Methodology is definitely not risk sensitive.
It is noted that there is no provided evidence to support adequacy of the suggested standardized / simplified factors.
Standardised methodologies can be useful to ensure the proportionality of the framework and provide an acceptable estimate of risk in case of banks of low size and/or complexity. However, they necessarily rely on simplistic assumptions which make them by definition less accurate than internal models (but not more conservative). The more complex the bank, the more sophisticated models are needed to manage and measure interest rate risk.
Therefore, we have very strong concerns that standardised methodologies could have to be mandatorily applied to a bank. As Article 98(3-4) refers to the standardized and simplified methodologies that the competent authority could impose for the evaluation of risks, we recommend that the RTS clarifies that such an imposition should be:
• limited to the evaluation (which will be necessarily wrong as mentioned before) and not for the actual management (as banks would have to manage with flawed steering metrics that would be detrimental to the actual risk management) as clearly mentioned in Art.98(3) “A competent authority may require an institution to use the standardised methodology referred to in paragraph 1 where the internal systems implemented by that institution for the purpose of evaluating the risks referred to in that paragraph are not satisfactory.”;
• conditional on competent authority having demonstrated that the standardized (resp. simplified) methodology would be more relevant than the IMS-evaluation that it would pretend substituting.
And we recommend that, as specified in the Directive, it is made clear that the standardized (simplified) methodology does not have to be implemented, unless imposed or elected by the bank, and should not be used as a benchmark for IMS.
As regards the proposed approaches, certain aspects should be addressed.
As an example, the suggested caps on Non Maturing Deposits (NMDs) may significantly distort the economic representation of interest rate risk.
As another illustration, it is not appropriate to use a stress volatility when measuring the sensitivity of automatic options in the objective of hedging them. With such an approach, one would be led to un-appropriate delta hedge of the options since the measurement would be distorted. It is highlighted that such a stress on volatility is neither performed in trading book nor required by the regulators for trading books regulations. By the way, requiring this to be applied for the Supervisory Outlier Test (SOT) on Economic Value of Equity (EVE) is inconsistent with the objective of the SOT EVE which is to measure the sensitivity to changes in interest rates.
The CP envisages changing the definition of commonly understood Net Interest Income (NII) to include changes in fair values of instruments even though they are not part of NII. This appears as a deviation from the CRR mandate that explicitly refers to NII. It also deviates from Basel Committee on Banking Supervision (BCBS) Standard that is quite explicit that it refers to NII excluding changes in fair values that do not affect NII. This would also be at odds with actual risk management and would introduce overlapping between NII measures and Economic Value (EV) measures, such as SOT EVE and SOT NII, while they should be complementary.
NII should be kept as defined by interest income and expenses.
Last but not least, the final application date should be aligned with the Guideline and the RTS on Supervisory Outlier Tests.
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?
n/aQuestion 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.
n/aQuestion 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.
n/aQuestion 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?
n/aQuestion 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?
n/aQuestion 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?
n/aQuestion 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)?
It is worth reminding that the Basel Committee on Banking Supervision (BCBS) has clearly mentioned that IRRBB is not amenable to standardization as any standardized measure of IRRBB would lose its risk-sensitivity and would fail to be relevant for supervisory measures:§3. The Committee noted the industry’s feedback on the feasibility of a Pillar 1 approach to IRRBB, in particular the complexities involved in formulating a standardised measure of IRRBB which would be both sufficiently accurate and risk-sensitive to allow it to act as a means of setting regulatory capital requirements. The Committee concludes that the heterogeneous nature of IRRBB would be more appropriately captured in Pillar 2.
In that context, a Standardized (or Simplified) Methodology is definitely not risk sensitive.
It is noted that there is no provided evidence to support adequacy of the suggested standardized / simplified factors.
Standardised methodologies can be useful to ensure the proportionality of the framework and provide an acceptable estimate of risk in case of banks of low size and/or complexity. However, they necessarily rely on simplistic assumptions which make them by definition less accurate than internal models (but not more conservative). The more complex the bank, the more sophisticated models are needed to manage and measure interest rate risk.
Therefore, we have very strong concerns that standardised methodologies could have to be mandatorily applied to a bank. As Article 98(3-4) refers to the standardized and simplified methodologies that the competent authority could impose for the evaluation of risks, we recommend that the RTS clarifies that such an imposition should be:
• limited to the evaluation (which will be necessarily wrong as mentioned before) and not for the actual management (as banks would have to manage with flawed steering metrics that would be detrimental to the actual risk management) as clearly mentioned in Art.98(3) “A competent authority may require an institution to use the standardised methodology referred to in paragraph 1 where the internal systems implemented by that institution for the purpose of evaluating the risks referred to in that paragraph are not satisfactory.”;
• conditional on competent authority having demonstrated that the standardized (resp. simplified) methodology would be more relevant than the IMS-evaluation that it would pretend substituting.
And we recommend that, as specified in the Directive, it is made clear that the standardized (simplified) methodology does not have to be implemented, unless imposed or elected by the bank, and should not be used as a benchmark for IMS.
As regards the proposed approaches, certain aspects should be addressed.
As an example, the suggested caps on Non Maturing Deposits (NMDs) may significantly distort the economic representation of interest rate risk.
As another illustration, it is not appropriate to use a stress volatility when measuring the sensitivity of automatic options in the objective of hedging them. With such an approach, one would be led to un-appropriate delta hedge of the options since the measurement would be distorted. It is highlighted that such a stress on volatility is neither performed in trading book nor required by the regulators for trading books regulations. By the way, requiring this to be applied for the Supervisory Outlier Test (SOT) on Economic Value of Equity (EVE) is inconsistent with the objective of the SOT EVE which is to measure the sensitivity to changes in interest rates.
The CP envisages changing the definition of commonly understood Net Interest Income (NII) to include changes in fair values of instruments even though they are not part of NII. This appears as a deviation from the CRR mandate that explicitly refers to NII. It also deviates from Basel Committee on Banking Supervision (BCBS) Standard that is quite explicit that it refers to NII excluding changes in fair values that do not affect NII. This would also be at odds with actual risk management and would introduce overlapping between NII measures and Economic Value (EV) measures, such as SOT EVE and SOT NII, while they should be complementary.
NII should be kept as defined by interest income and expenses.
Last but not least, the final application date should be aligned with the Guideline and the RTS on Supervisory Outlier Tests.