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The Reserve Bank of India has issued final guidelines on interest rate risk in banking book (IRRBB), whereby banks have to measure, monitor, and disclose their exposure to IRRBB in terms of potential change in the economic value of equity and net interest income, computed based on a set of prescribed interest rate shock scenarios.
IRRBB refers to the current or prospective risk to banks’ capital and earnings arising from adverse movements in interest rates that affect its banking book positions, per the guidelines.
The central bank said the Board will be responsible for ensuring that steps are taken by the bank to identify, measure, monitor and control IRRBB, consistent with the approved strategies and policies.
Monitoring and management of IRRBB can be delegated by the Board to ALCO (asset-liability committee), which should regularly monitor the nature and the level of the bank’s IRRBB exposure, the guidelines read.
The Board/ALCO (Asset-Liability Co) is responsible for setting appropriate limits on IRRBB; valuing positions and assessing performance, including procedures for updating interest rate shock and stress scenarios and key underlying assumptions driving the institution’s IRRBB analysis; and a comprehensive IRRBB reporting and review process, among others.
The RBI said banks should have a clearly defined Board-approved risk appetite statement which lays down policies and procedures for limiting and controlling IRRBB.
The statement should lay down Board-approved aggregate IRRBB limit given the bank’s business strategies at the consolidated bank level as also at the level of individual entities as appropriate.
Sub-limits
Depending on the nature of a bank’s activities and business model, sub-limits may also be identified for individual business units, portfolios, instrument types or specific instruments.
The risk appetite framework should delineate delegated powers, lines of responsibility and accountability over IRRBB management decisions and should clearly define authorised instruments, hedging strategies and risk-taking opportunities.
Identify IRRBB in products
Banks have been asked to identify the IRRBB inherent in products and activities and ensure that these are subject to adequate procedures and controls.
Significant hedging or risk management initiatives must be approved before being implemented.
“Products and activities that are new to a bank must undergo a careful pre-acquisition review to ensure that the IRRBB characteristics are well understood and subject to a predetermined test phase before being fully rolled out.
“Prior to introducing a new product, hedging or risk-taking strategy, adequate operational procedures and risk control systems must be in place,” it said.
Banks are required to have systems in place to ensure that positions which exceed or are likely to exceed limits defined by the Board should receive prompt management attention and be escalated without delay.
The RBI said banks should have their IRRBB identification, measurement, monitoring and control processes reviewed by an independent auditing function (such as an internal or external auditor) on a regular basis. All IRRBB policies should be reviewed periodically (at least annually) and revised as needed.
Stress testing framework
The central bank asked banks to develop and implement an effective stress testing framework for IRRBB as part of their broader risk management and governance processes, which should be commensurate with their nature, size and complexity as well as business activities and overall risk profile.
This framework should feed into the decision-making process at the appropriate management level, including strategic decisions (e.g. business and capital planning decisions) of the Board or its Committee.
In particular, IRRBB stress testing should be considered in the Internal Capital Adequacy Assessment Process (ICAAP), requiring banks to undertake rigorous, forward looking stress testing that identifies events of severe changes in market conditions which could adversely impact the bank’s capital or earnings, possibly also through changes in the behavior of its customer base.
Capital adequacy for IRRBB
The capital adequacy for IRRBB should be considered in relation to the risks to economic value, given that such risks are embedded in banks’ assets, liabilities and off-balance sheet items, per the guidelines
For risks to future earnings, given the possibility that future earnings shall be lower than expected, banks should consider capital buffers.
The RBI said the date for implementation of the guidelines on IRRBB will be communicated in due course. Banks have been advised to be in preparedness for measuring, monitoring, and disclosing their exposure to interest rate risk in the banking book in terms of this circular.
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