26 JUNE 2015 – NtInsight® for ALM, Numerical Technologies software solution for asset/liability management, supports the key requirements presented by the Basel Committee on Banking Supervision (BCBS) in its consultative document on interest rate risk in the banking book (IRRBB). The document released on June 8 proposes changes to the regulatory capital treatment and supervision of IRRBB. These proposals and the NtInsight® for ALM features that support them are discussed below.
IRRBB Requirements and NtInsight® for ALM Features
| No | IRRBB Requirements | NtInsight® for ALM Features |
|---|---|---|
| 1 | Banks’ internal measurement systems (IMS) should capture all material sources of interest rate risk. | NtInsight® captures current and prospective risk such as gap risk, non-parallel gap risk, optionality risk, and basis risk, taking into account various factors including prepayment. |
| 2 | IMS should be based on economic value (EV) as well as on earnings (i.e., on net interest income (NII) and other metrics as prescribed by supervisors). | NtInsight® computes EV and NII based on fully-captured cash flows. |
| 3 | Banks should use a variety of systems, ranging from simple calculations based on static simulations using current holdings to more sophisticated dynamic modelling techniques that reflect potential future business activities. | NtInsight® supports both static and dynamic portfolio simulation using the future investment planning feature. |
| 4 | IMS should incorporate not only a bank’s internally-selected set of interest rate shock scenarios, but also supervisory-prescribed interest rate shock scenarios. | NtInsight® supports user-selected interest rate scenarios (i.e., both bank- and regulatory-selected scenarios, stress scenario, etc.). |
| 5 | Banks are required to calculate IRRBB minimum capital requirements using a standardised approach even when an internal model-based approach has been adopted. | NtInsight® will implement standardised approach once requirements are finalized. |
Details of NtInsight® for ALM Features
Risk Capture That Takes into Account Various Factors
The consultative document defines four main IRRBB subtypes, namely gap risk, non-parallel gap risk, optionality risk, and basis risk. NtInsight® for ALM takes into account various factors when capturing these types of risks. For example, NtInsight® for ALM can calculate behavioral option risk using a prepayment model.
EV and NII Calculations Based on Fully-Captured Cash Flows
NtInsight® for ALM can capture the future cash flows generated from a banking book assets and liabilities in detail (i.e., each cash flow created by each transaction is traceable). The change in the present value of cash flows represents the change in EV. The system also enables risk managers to grasp the individual accounting period’s change in cash flows, thus allowing them to understand NII.
Support for Both Static and Dynamic Portfolio Simulation
In addition to static simulations where the original portfolio remains unchanged, NtInsight® for ALM provides an investment planning feature where a portfolio can be rearranged dynamically during simulation. This feature allows risk managers to analyze future earnings with a dynamic view, which should be taken into account in the internal model.
Support for Setting User-Selected Interest Rate Scenarios
With NtInsight® for ALM, risk managers have the ability to choose the economic environment applied to their financial simulations. Through this feature, managers can calculate economic value and earnings using either the bank’s internally-selected interest rate shock scenarios or the supervisory-prescribed scenarios.
In addition to the above, Numerical Technologies is prepared to implement the standardised approach required by the standardised Pillar 1 approach and the enhanced Pillar 2 approach.
Summary of the Consultative Document, Interest Rate Risk in the Banking Book
The consultative document puts forward two proposals with regard to the capital treatment of IRRBB:
- Standardised Pillar 1 (Minimum Capital Requirements) approach
It requires banks to add the minimum capital requirements for IRRBB that is calculated using a standardised approach. - Enhanced Pillar 2 approach
This approach does not automatically impose the addition of the capital requirements, however, it requires the standardised disclosure of IRRBB calculations.
The Pillar 1 approach requires banks to follow a standardised approach in the calculation of IRRBB. The consultative document presents four proposals with regard to the minimum capital requirements calculation. One of the proposed methods bases the capital requirements purely on economic value, while the rest use both economic value and earnings as bases.
Enhanced Pillar 2 approach requires banks to disclose IRRBB calculations measured using the standardised approach as well as those measured using the banks’ internal model. The disclosure requirements in detail are:
- Internal model
- According to internally-selected interest rate shock scenarios
- Increase/decline in economic value
- Increase/decline in earnings
- Model assumptions over key model parameters
- According to the six regulatory interest rate shock scenarios
- The percentage change in the ratio of the change in the economic value of equity to Common Equity Tier 1
- The percentage change in projected net interest income (NII) measure
- According to internally-selected interest rate shock scenarios
- Standardised approach
- According to the six regulatory interest rate shock scenarios
- Result of the fallback standardised framework
- According to the six regulatory interest rate shock scenarios
