IRRBB and CSRBB: Interest rate risk management climbs the agenda

July 2023

Recent months have seen Interest Rate Risk in the Banking Book (IRRBB) and Credit Spread Risk in the Banking Book (CSRBB) firmly in the spotlight of Europe’s banks — and banking supervisors.

This is partly about regulation: The European Banking Authority’s (EBA) finalised Guidelines establish CSRBB as a separate risk category, introduce a periodic Supervisory Outlier Test, and promise to significantly increase regulatory reporting requirements.

This is also about the market: Banks are also seeing that market conditions have a direct impact on their profit & loss statement (P&L) and balance sheet. Sharp increases in central bank base rates, the dwindling of quantitative easing, and high-profile banking failures in the US have all sharpened the industry’s focus on interest rate and credit spread risks.

Given these exceptional circumstances, In May 2023 KPMG conducted a benchmarking analysis of 47 banks from 10 EBA relevant countries, aiming to summarise current market practices on IRRBB and CSRBB, and to identify areas for enhancement. Our results show that banks expect market and regulatory pressures to continue, with significant near-term implications. We highlight three key findings here.

First, regulatory reporting for IRRBB is expected to be a major challenge.

Implementing the proposed templates by the second half of 2024, as suggested by the EBA, will likely pose a high to very high implementation hurdle for almost all banks.

Major challenges identified by participants include:

• The granularity of required data at the product level
• Ensuring consistency with other regulatory reporting, such as Financial Reporting (FINREP) and Common Reporting (COREP)
• The sheer number of data sources needed to complete the template

Given that many banks will need to collect data from multiple separately managed systems, agreeing on the hierarchy of data could also be difficult. For example, if separate models are used to calculate the sensitivity of Economic Value of Equity (EVE) and Net Interest Income (NII), it is unclear which will provide the reference point for the interest rate gap profile and how inconsistencies will be remediated. Completing the template will require a cross-divisional approach, with cooperation between risk reporting, risk control, finance and treasury.

Second, many banks are not yet fully gauging the fair-value effects of interest rate shocks.

Only slightly more than 40 percent of participants are ready to measure fair-value impacts from interest rate changes on both the P&L and Other Comprehensive Income (OCI) — something that supervisors want to see. So far, most banks have concentrated their efforts on NII. Readiness is higher among banks directly supervised by the European Central Bank (ECB), but is still below 60 percent in our sample.

Given that the new EBA Guidelines place increased emphasis on the earnings perspective (consisting of NII and fair-value effects) rather than on the NII or EVE alone, banks should adjust their steering approach to interest rate risks. This shift is likely to be reinforced by market discipline. Rapid interest rate movements led to many banks suffering significant asset valuation losses in 2022 and, in some cases, recording accounting losses for the year. Investors are increasingly aware of the accounting mismatches that can arise from interest rate swings, necessitating changes to risk steering approaches. This is likely to have skills implications, such as giving accounting experts a greater IRRBB role to ensure that valuation effects are well understood and communicated.

Third, there is persistent uncertainty regarding regulatory expectations around CSRBB.

This is greatest when it comes to the scope of credit spread sensitive instruments, with many banks unsure whether to include their own issuances and corporate loans. However, banks do agree on the inclusion of bond assets, irrespective of their accounting treatment.

The Guidelines themselves provide banks with a significant degree of freedom on how to determine if a product is credit spread sensitive. We therefore expect to see a wide range of approaches to the scope of CSRBB, at least until the ECB and national supervisors clarify their expectations. Greater harmonisation will likely emerge over time, making risk data more comparable between institutions.

Key recommendations for banks

In short, our analysis suggests that the expectations of investors and regulators regarding IRRBB and CSRBB will tie up significant banking resources over the next couple of years.

In response, we recommend that banks waste no time in starting to analyse the new regulatory reporting requirements in detail, instead of waiting for the final Implementing Technical Standards (ITS) expected later this year.

Banks should also get a head start on the implementation of CSRBB. It is unlikely that every bank will be able to implement all the requirements quickly, but with some workarounds and a focused approach the implementation of core requirements can be prioritised — leaving room for refinements further down the road.

Finally, banks should take the opportunity to develop a comprehensive interest rate steering framework, including both risk and accounting figures, enabling them to take advantage of altered market rates without creating excessive short-term P&L volatility.