Avantage Reply was engaged to create a new interest rate risk in the banking book (IRRBB) model in full compliance with all regulatory requirements.
A new model was delivered that is easy to use and provides sufficient flexibility to enable the bank to use it to assess strategical evolutions such as the creation of a new product.
Our client is a bank which has two main areas of business: (1) providing investment loans to high net worth individuals (collateralized by various assets); and (2) providing credit card acquiring services (i.e. offers to process card transactions of merchants).
Our client had an existing model to manage and quantify Interest Rate Risk in the Banking Book (IRRBB). However their regulator had identified a number of shortcomings in the model which required the bank to review the model to ensure it fully complied with the regulatory requirements; in particular the “Guidelines on the management of interest rate risk arising from non-trading activities” issued by the EBA on 22 May 2015.
The existing model, which was implemented a few years back, estimated the impact on earnings and economic value of a +/- 200 basis point shock. However the model could not apply non-parallel yield curve shocks. Furthermore, the model was not fully documented.
The client requested that the new model not only covers the existing products offered by the bank but also supports two products soon to be launched – retail loans and deposits. Finally, the model should enable the bank to easily implement the new standardised framework defined by the Basel Committee on Banking Supervision in April 2016 and expected to be implemented by the revision to the Capital Requirements Regulation and Directive.
The implementation of a new IRRBB tool focused on three aspects:
1. Documentation of the bank’s products and services – The existing IRRBB model had some outdated and incorrect assumptions regarding the bank products and services. A short document was created where the relevant interest rate and behavioural information of every product and service offered by the bank were described. Each section of this document was signed-off by the relevant business head and became the basis to ensure that all products and services are appropriately modelled.
2. Input data review – Significant work was performed to ensure that inputs are exhaustive (i.e. that all interest rate relevant positions are covered) and accurate. This was performed by reviewing the inputs against both the balance sheet and the document describing all the services and products.
3. Model creation – Avantage Reply created a new model which applies various interest rate shocks to measure interest rate risk. In addition a full model documentation and a user manual were delivered.
The main benefits of the new model are:
New interest rate scenarios can easily be added to measure both the impact on earnings and economic value.
The model supports:
New positions can be added to estimate the impact of a new product offering, assets growth or other evolutions.
The new model was successfully delivered and addressed all the comments made by the supervisory authorities. Because the model is computationally fast and new, products or assumptions can easily be added the bank has used it to assess strategic options.