Thematic review: Room for development in the measurement of interest rate risk and management of interest rate risk models by credit institutions under direct FIN-FSA supervision

The FIN-FSA carried out a thematic review examining how credit institutions under the FIN-FSA's direct supervision comply with the EBA's updated interest rate risk regulation published in October 2022¹ in terms of the measurement of interest rate risk and management of related models. The thematic review survey consisted of three areas:

• measurement methods for economic value of equity (EVE) and net interest income (NII)
• modelling of non-maturity deposits, loan prepayments and early withdrawals of fixed term deposits
• management of interest rate risk measurement methods and interest rate risk models

The thematic review showed that the measurement of interest rate risk and management of both measurement methods and models by credit institutions under the FIN-FSA's direct supervision need development to achieve compliance with the requirements of the EBA Guidelines and the standards specified below. There were shortcomings both in the credit institutions’ own methods, supervisory outlier tests and particularly in the management of the measurement methods and models. Shortcomings concerning the measurement methods and models combined with their incomplete management give grounds for questioning the reliability of the results presented by the credit institutions on their interest rate risk measurements. 

It is noteworthy that the delegated act on the standards specified below has not been published yet. However, the regulation has in many respects been the same as in the earlier version of the EBA Guidelines that entered into force on 30 June 2019.

In the thematic review, the following shortcomings were identified:

• Credit institutions’ own interest rate risk measurement methods are not consistent with the EBA’s IRRBB & CSRBB Guidelines. There were deviations, among other things, in the consideration of interest rate-sensitive items, market value changes and basis risk as well as in the modelling of non-maturity deposits. 
• Credit institutions applying the standardised method do not, in all respects, apply the Standard (RTS on SA). For example, credit institutions do not allocate cash flows into time buckets or consider basis risk in accordance with the Standard. 
• The supervisory outlier tests are not consistent with the Standard. Deviations were identified, for example, in the consideration of interest rate-sensitive items, treatment of margins, balance sheet assumptions, shock scenarios, application of the floor in the shock scenario, aggregation of currencies and the modelling of non-maturity deposits.
• The management of the models and measurement methods by most of the credit institutions was at a weak level and also inconsistent with the recommendations of the EBA’s IRRBB and CSRBB Guidelines. Many credit institutions lacked formal policy processes altogether. The regular review and validation of measurement methods and key assumptions of the models as well as their initial validation require development.
• Documentation related to the measurement methods of interest rate risk and model management was incomplete and at a too general level.

The FIN-FSA will review the credit institution-specific findings and recommendations together with each credit institution that participated in the thematic review.

In the measurement of interest rate risk, credit institutions may use either their own models or the standardised method (small and non-complex institutions may also use the simplified standardised approach). In addition, all credit institutions must measure interest rate risk by supervisory outlier tests under the RTS. The thematic review comprised an assessment of the credit institution's own methods or the standardised method, if the credit institution applies it, and the supervisory outlier tests.

The starting point for the supervisory outlier tests and the standardised method is that the credit institution must apply standardised assumptions even where its own method is more comprehensive, conservative, or better applicable to the credit institution's strategy. The purpose of standardised assumptions is to improve the comparability of different credit institutions.

However, credit institutions should not merely rely on the supervisory outlier tests, as they should also develop their own interest rate measurement methods. These own methods must be based on the credit institution's specific situation and account for all interest rate risk components involved in its financing activities. The assumptions must be consistent with the business strategies, and they must be tested and validated on a regular basis.

For further information, please contact

Marjo Risku, Chief Specialist, telephone +358 9 183 5275 or marjo.risku(at)fiva.fi

Appendices

• FIN-FSA supervision release of 14 November 2022 – 51/2022:EBA has published a regulatory package on IRRBB (in Finnish)
• FIN-FSA supervision release of 2 May 2023 – 27/2023:Amendments to regulations and guidelines 5/2015 on the management of interest rate risk arising from non-trading activities and of credit spread risk enter into force on 30 June 2023

¹The regulatory package included: guidelines on interest rate risk (IRRBB) and credit spread risk (CSRBB) arising from non-trading book activities, a draft RTS on the IRRBB standardised and simplified-standardised approaches and a draft RTS on the supervisory outlier tests (SOT)