The Principles of Banking, 2nd Edition

CHAPTER 7Managing Interest-Rate Risk in the Banking Book (IRRBB)¹

Abstract

In the ordinary course of business banks will generate interest-rate risk on the balance sheet. This is the risk that earnings, and theoretically balance sheet economic value, will reduce if and when market interest rates change. This risk type is referred to by regulators as interest-rate risk in the banking book (IRRBB). There is specific regulatory guidance on how banks should define, measure, monitor, manage and report on IRRBB. Good practice dictates that a bank has in place a Board-approved IRRBB policy that describes how it will manage IRRBB. The risk is measured using two metrics, an earnings-related exposure metric (“NII Delta”) and an economic value metric (“EVE Delta”), and the application of both standardised and tailored stressed scenario tests.

Conventional bank loan and deposit products that do not re-price while they are on the balance sheet are held in the “banking book”, also referred to as the “accruals” book. Products in the banking book are recorded at origination value (generally 100, or “par”) and remain at that value until maturity (or removal from the balance sheet). An absence of regular revaluation or “marking-to-market” does not mean that the book is without market risk, however, or at least earnings (P&L) risk, because of the funding structure that banks use. Assets are long-dated and liabilities are in the main short-dated, so if the cost of funding rises there is a potential ...