Basel Committee Proposes Stronger Management of Interest Rate Risk in the Banking Book

On November 9, the Basel Committee on Banking Supervision (BCBS) issued a consultation document on supplementary Pillar 2 guidance for interest rate risk in the banking book, proposing stronger bank management of risks from interest rate fluctuations. Interest rate risk in the banking book arises when changes in interest rates affect the value of a bank’s assets and liabilities and its income. It can stem from mismatches in the timing of interest rate adjustments between assets and funding sources, differences in movements among interest rate benchmarks, and options embedded in banking products.

The committee recommends that banks strengthen validation of their risk measurement models, focusing on forecasts of demand deposit behavior, deposit pricing and prepayment rates. Banks should compare forecasts with actual outcomes, conduct independent assessments and update models when market conditions or business structures change. Even when using third-party models and data, they must assess whether these suit their business characteristics and risk profiles.

The consultation document also recommends expanding stress tests to include scenarios with interest rates rising and falling by varying amounts, assessing significant balance sheet items and the sensitivity of model assumptions, and reporting the results to senior management and supervisors. Banks should combine economic value measures with short- and medium-term earnings measures, including the sensitivity of net interest income, to assess the effects of interest rate changes on assets, liabilities and operating performance.

For investment securities portfolios, the committee recommends that banks track gains and losses caused by interest rate changes that have not been fully reflected in their accounts, and quantify their effects on the economic value of equity and capital adequacy under different market scenarios. For supervision, the committee proposes comparing banks of similar size, business model and deposit structure, and adding supervisory information on models, risk hedging, earnings measures and potential gains and losses to identify banks with higher interest rate risk.

Source: VietVance