Learning Objectives:

  • Understand the sources of interest rate risk in the banking book.

  • Apply measurement techniques, including EVE and NII sensitivity.

  • Explain the regulatory framework for IRRBB.

4.1 Sources of Interest Rate Risk

The University of Birmingham’s International Treasury Management module covers the “structure, organisation, operations and functions of a treasury department” . Key sources of IRRBB include:

  • Gap/Repricing Risk: Risk from mismatches in the repricing dates of assets and liabilities .

  • Basis Risk: Risk from changes in the relationship between different interest rates .

  • Option Risk: Risk from embedded options (e.g., prepayment of mortgages, early withdrawal of deposits) .

  • Yield Curve Risk: Risk from changes in the shape of the yield curve .

4.2 Measurement Techniques

Economic Value of Equity (EVE): Measures the impact of interest rate changes on the economic value of the bank’s equity. The NPTEL course covers “Economic value of equity sensitivity analysis” .

Net Interest Income (NII) Sensitivity: Measures the impact of interest rate changes on net interest income over a specified horizon .

Value at Risk (VaR): A statistical measure of potential loss from adverse interest rate movements .

4.3 Regulatory Framework

The Basel Committee provides guidance on the management of IRRBB. Key requirements include:

  • IRRBB Framework: Banks must have a robust framework for measuring and managing IRRBB.

  • Stress Testing: Banks must conduct stress testing to assess the impact of extreme interest rate movements.

  • Capital Requirements: Banks must hold capital for IRRBB.

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