Navigating IRRBB and CSRBB

October 2024

The banking turmoil in the US last spring was a stark reminder of the risks from sudden changes in interest rates and credit spreads. Indeed volatility in these areas has had a direct impact on European banks’ profit and loss statements (P&L) and balance sheets over the past two years. This has prompted supervisors to increase their focus on Interest Rate Risk in the Banking Book (IRRBB) and Credit Spread Risk in the Banking Book (CSRBB) – including via new IRRBB reporting requirements introduced by the European Banking Authority’s (EBA) Implementing Technical Standard (ITS).

Banks have already committed more resources to meeting heightened IRRBB and CSRBB expectations, but supervisory attention continues to grow. One of the European Central Bank’s (ECB) Supervisory priorities for 2024-2026opens in a new tab is to:

"Challenge banks’ interest rate risk management framework to ensure they properly reflect prudent assumptions regarding customer behaviour and develop corresponding mitigation strategies commensurate to their risk profiles"

In consequence, the ECB has recently begun a new round of on-site inspections (OSIs) focusing on IRRBB and CSRBB. Key areas of scrutiny are likely to include:

Risk measurement and quantification

Scenario selection and risk coverage

Economic value of equity (EVE) and net interest income (NII) risk metrics

Behavioural modelling and customer sensitivities

Some key challenges facing banks

KPMG has recently conducted a fresh benchmarking exercise to better understand banks’ IRRBB and CSRBB circumstances, challenges and priorities in 2024. This study, which collected answers from more than 90 banks to a range of questions about current market practices and forthcoming changes, reveals many interesting and detailed findings. Three of the most notable headlines to emerge are as follows:

In our 2023 article we highlighted that implementing the EBA’s new IRRBB reporting requirements by the second half of 2024 represented a high hurdle for many banks. Since then, the data quality challenges of these requirements have only become more apparent, with key difficulties including the availability, completeness, and the dispersal of key data across multiple systems and databases.

Banks are working to overcome these limitations, but there is much to do. Many institutions are still reliant on a significant level of manual, Excel-based workarounds and other individual data processing (IDP) solutions — with consequences for speed, cost and reliability. Adding to the difficulty, the ECB has made clear that the approximately 4,000 data fields all need to meet the high standards set out in Basel Committee on Banking Supervision (BCBS) 239.

As a result of these challenges, some banks have already received high impact findings on data quality from recent OSIs.

To measure maturity mismatches on their balance sheets, banks have always made assumptions about the run-down of their customer deposits over daily, weekly and monthly horizons. A standardised deposit model is not prescribed by regulation, but the underlying assumptions do fall within supervisors’ IRRBB scrutiny.

Since 2022, rapid and significant swings in interest rates have changed market conditions and pushed banks into a steep learning curve on deposit behaviour. For example, term deposits have become more important. Some banks have also received negative findings from recent OSIs, for instance on customers’ sensitivity to rate changes and the speed of migration between interest-bearing and non-interest-bearing accounts.

KPMG’s benchmarking shows that these factors have prompted widespread alterations to deposit modelling, with 20 percent of banks surveyed having already modified their non-maturity deposit (NMD) modelling and a further 45 percent planning to do so in the near future.

The EBA differs from the Basel Committee by including both assets and liabilities in the scope of CSRBB. The EBA’s Guidelines have given significant latitude to judge which products are credit spread sensitive. Most respondents agree on the inclusion of all bonds – whether held at Fair Value or Amortised Cost – when calculating credit spread sensitivities. However, many are hoping the ECB will clarify its expectations in other areas like the treatment of corporate loans.

In addition, the CSRBB treatment of banks’ own issuances remains hotly debated. In 2023, 25 percent of participants planned to include their own liabilities in scope; now, no fewer than 60 percent plan to do so. This is likely to cause a significant shift in sector sentiment, but it is worth noting that the inclusion of liabilities could have a penalising effect on institutions with specialised business models or funding structures, such as development or infrastructure banks.

Key takeaways and areas of action

Based on KPMG’s benchmarking findings and the experience to date of banks undergoing OSIs, we view the following as among the areas where banks should prioritise their preparations for regulatory scrutiny of IRRBB and CSRBB:

Data quality

Centralise and standardise data warehouses for greater consistency. Improve and align IRRBB standards for data quality and granularity to meet BCBS 239 standards. Anticipate assessments of quantification methods, defined metrics, and the reconciliation of accounting data with regulatory and Internal Capital Adequacy Assessment Process (ICAAP) views.

Deposit modelling

Reassess model assumptions and parameters in light of the changed market environment within the past two years and potentially recalibrate the model, expect in-depth analysis of behavioural models and non-maturity deposit models and consider incorporating the migration between current and saving accounts into the model.

CSRBB

Prepare to be challenged by the supervisor and required to increase the CSRBB scope — e.g. reconsider assumptions regarding credit spread sensitive positions, like own issued bonds.

Last year’s banking turmoil was a warning of the potential risks from rapid changes in interest rates. Supervisors were relieved at European banks’ resilience then, but are determined to ensure banks properly manage this risk in the years ahead.