Final standard on IRRBB by FINMA in Switzerland
  • Thursday, 23 August 2018

Final standard on IRRBB by FINMA in Switzerland

Recently, FINMA published the final standard on the management of interest rate risk in the banking book (IRRBB). This publication marks the end of a vivid debate in the Swiss banking sector on how interest rate risk from non-trading book activities should be measured, monitored and assessed internally, as well as reported externally to the regulator. The standard becomes effective as of January 1st 2019.

Although the final standard is generally based on the Basel Standard “Interest Rate risk in the Banking Book” (BCBS 368) as of April 2016, a number of differences can be identified. The main deviations from BCBS 368 are highlighted below.

  • FINMA provided more specific guidance on the proportionality principle than BCBS. Also the scope has been broadened. Small banks (category 4 and 5) and category 3 banks, which have a net interest income (NII) that is less than 1/3 of total earnings, are exempt from specific regulatory requirements measuring and reporting interest rate risk. The consultative document published by FINMA in October 2017 had initially only banks in category 4 and 5 in scope of the proportionality principle;
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  • Regarding risk identification, FINMA included credit spread risk (CSRBB) in scope of measuring and monitoring IRRBB (besides gap risk, basis risk and option risk), similar like BCBS. However, FINMA argued that High Quality Liquid Assets (Category 1) as well as “Pfandbrief” instruments, issued by the Pfandbriefbank der Schweizer Hypothekarinstutute AG or Pfandbriefzentrale der Schweizer Kantonalbanken AG, can be excluded from measurement and assessment of CSRBB. Exclusion of both types of instruments was not mentioned in FINMA’s consultation paper.
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  • FINMA is less strict than BCBS on defining the bank’s risk appetite in terms of both an economic value as well as earnings perspective. Risk appetite and limits should at least be defined from an economic value perspective. In case of relevance in individual cases or circumstances, risk appetite and limits can also be defined from an earnings perspective. In the final standard, FINMA does not clearly describe what is meant with relevance and when individual circumstances apply. In the consultation paper, however, risk appetite and limits were initially defined in terms of both economic value and earnings based measures.
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  • Broadness of the interest rate (shock and stress) scenarios used in measuring IRRBB is addressed by FINMA. The final standard provided considerably more guidance on the rate shocks to be applied under the 6 standard scenarios for various currencies, than BCBS. Furthermore, FINMA does not prescribe rates to be ‘floored’, when rate shocks result into negative rates. Contrary to BCBS, however, the statement that IRRBB should be measured through both economic value and earnings based measures has been softened. In addition, the standard does not provide full guidance on the approaches that can be used to determine economic values of A/L and EVE. This relates to stripping (client) margins from cash flows and discounting against either a risk-adjusted curve or ‘risk-free’ (LIBOR-Swap) curve. Since most Swiss banks currently discount (unstripped) cash flows against LIBOR-Swap, it is expected this approach continues to be the preferred method used for economic value and EVE calculations. FINMA’s consultation paper also did not provide clear guidance.
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  • With respect to model assumptions, banks need to review and assess the impact of key behavioural and model assumptions on interest rate risk at least on an annual basis. Banks in scope of the proportionality principle need to do this every 3 years (assuming the business model, client and product mix as well as market environment do not materially change). On this point, FINMA differentiated herself from BCBS. This is unchanged following the consultation paper.
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  • Public disclosure requirements on IRRBB follow the FINMA-Rundschreiben 2016/1 “Offenlegung – Banken”. This standard has been recently updated also. Disclosure of IRRBB will be as of June 30th 2019 and afterwards every year as of 31st December. With respect to capital adequacy, banks must not only rely on the supervisory assessment of capital adequacy for IRRBB, but should also develop their own internal model for capital allocations. FINMA-Rundschreiben 2011/2 “Eigenmittelpuffer und Kapitalplanung” provides further guidance. Both FINMA and BCBS apply the same criterion (15% of Tier 1 capital) in the supervisory outlier test (SOT). This is unchanged following the consultation paper.

The final IRRBB standard by FINMA is less prescriptive and detailed compared to BCBS 368 (or the EBA 2018 final guidelines). This leaves more room for divergence in implementation among banks.

Although the final standard also did not materially change compared to the consultative document published by FINMA in October 2017, a timely implementation can still prove to be challenging for many banks in Switzerland. See also Zanders’ article on the challenges faced by Swiss banks. Hence, the implementation of the new standard should be one of the top priorities for each bank, because the standard becomes effective already beginning of 2019.

Get in touch with Sjoerd Blijlevens or Martijn Wycisk for more information about IRRBB.

IRRBB Quick Scan

Should you want to assess your bank’s IRRBB framework, Zanders offers an IRRBB Quick Scan. Based on a review of available model documentation, risk reports and interviews with your bank’s risk specialists, the scan provides an independent and objective assessment of your bank’s IRRBB implementation relative to the new IRRBB principles and best-market practices. More information on the IRRBB Quick Scan can be found here.