Introduction
Over the past few years, a series of events have significantly altered the landscape of bank supervision for the foreseeable future. Specifically, liquidity and interest rate risks have emerged as focal points for regulators. The spotlight on these risks intensified following the collapse of Silicon Valley Bank in March 2023, triggering a chain reaction that ultimately led to the downfall of Credit Suisse.
As a result, approximately 2.5% of total banking assets in the American banking system and 15% of the total assets in the Swiss banking system were lost. These losses can be attributed to various factors, including the high concentration of volatile deposits, the composition of debt portfolios, and inadequate management of interest rate risk. Additionally, the influence of new technologies, social networks, and apps has exacerbated bank runs, further contributing to the failures observed.
Key developments and timelines
On 24 January 2024 The European Banking Authority (EBA) its heatmap following scrutiny of the interest rate risk in the banking book (IRRBB) standards implementation in the EU, covering both short to medium-term objectives from 2024 to Mid-2025 and long-term goals beyond Mid-2025. This heatmap emphasises the need to bolster supervisory oversight and foster collaboration among institutions and regulators to enhance risk assessment and management practices. Furthermore, the EBA applies a twofold strategy divided in short to medium term objectives and medium to long term objectives.
In the short to medium term, key initiatives include researching supplementary indicators to complement the existing Supervisory Outlier Test (SOT), focusing on metrics related to Net Interest Income (NII).
Additionally, tailored analytical tools are being developed for supervisors to better identify and monitor parameters and risk factors used by banks in their behavioural models.
The EBA also aims to provide guidance on regulatory standards to ensure regulatory compliance and transparency within banks, particularly by intensifying scrutiny of provisions outlined in Article 5(d) of the Regulatory Technical Standards (RTS) on SOT regarding repricing issues on non-core Non-Maturing Deposits (NMDs) under the application of constant balance sheet. Specifically, the EBA seeks to assist institutions in avoiding misunderstandings regarding the application of the constant balance sheet assumption for the NII SOT metric. This guidance will ensure a proper NII estimate by conservatively capturing the impact of upward interest rate scenarios and avoiding the possibility of artificially inflating NII declines in downward scenarios.
Furthermore, continuous evaluation of banks' hedging techniques remains crucial, with a focus on improving risk management practices to effectively navigate market fluctuations. The EBA is actively participating in the Dynamic Risk Management (DRM) project of the International Accounting Standards Board (IASB) to ensure this evaluation.
Additionally, exploring potential developments of analytical tools aligned with Supervisory Review and Evaluation Process (SREP) Guidelines will become a main priority.
Due to the variety of models implemented by institutions, additional support might be required for both regulators and supervisors to better understand how the IRRBB risks are assessed and covered. This includes adaptation of modelling assumptions, repricing rates applied, hedging strategies, back-testing, and the use of professional judgment and manual adjustments (if any). The EBA will consider developing Q&As, as needed, and will further reflect on incorporating all necessary developments related to IRRBB to provide supervisors with additional guidance on assessing and reviewing the IRRBB risks of institutions to complement the guidelines. Finally, institutions will be subject to enhanced scrutiny by supervisors going forward, following the preliminary assessment of the results of the ITS on Pillar 3 disclosure of institutions’ exposure to IRRBB. This assessment highlighted that several institutions used different (lower) shock scenarios from the regulatory shock, different modelling assumptions, and undisclosed qualitative information.
All the work mentioned previously shall fall under short to medium-term actions, also to be undertaken in 2025 and beyond.
Looking ahead to the long term, initiatives include analysing the impacts of regulatory IRRBB products to ensure banks' resilience to interest rate fluctuations. There's a commitment to monitor the 5-year limit and addressing aspects of Credit Spread Risk in the Banking Book (CSRBB), particularly in defining the scope of instruments to be included in CSRBB assessments for comprehensive risk coverage within banking operations.
Implications for banks
The roadmap presented by the EBA to address IRRBB risk will entail significant implications for future banking decisions regarding IRRBB. Banks will need to adapt to evolving practices in behavioural modelling of NMDs, particularly in areas related to IRRBB measurement that require further analysis.
Regarding hedging strategies, ongoing monitoring and examination of hedging techniques (DRM) and further developments on disclosure aspects on hedging issues.
Additionally, the impact of a changing interest rates environment, more volatile and uncertainty, reflect the necessity to tackle IRRBB and liquidity aspects as risk that are closely related and, finally, enhancing transparency through improved publication under Pillar III.
Conclusion
Given recent events, it has become exceedingly clear that there is an urgent need to address liquidity and interest rate risks. Furthermore, it is important not to overlook that in certain jurisdictions where the EBA has intervened, IRRBB is regarded as a Pillar 1 risk.
In response, the EBA has launched a comprehensive plan to enhance oversight and collaboration among banks and regulators. This includes short-term goals like improving risk assessment tools, examination of hedging techniques and providing guidance about behavioural modelling aspects.
Additionally, long-term efforts are underway to strengthen stability, monitor the 5-year limit, and grant CSRBB a heightened level of coverage among the various risks that entities face. By systematically addressing these pivotal areas, the EBA strives to mitigate the adverse effects of liquidity and interest rate risks, thus fostering a more resilient banking environment for the future.
Contact us
Pablo Suarez Manjon
Trading and Market Risk Workstream Lead, Director, PwC Spain
Tel: +34 6764 89076
