ALM Forum

The manipulation of reference interest rates, including LIBOR and EURIBOR, which was uncovered in 2011, served as motivation for IOSCO (International Organisation of Securities Commissions) to initiate a reform of benchmarks. In 2016, the European Union subsequently adopted the Benchmark Regulation (BMR). Critical benchmarks had to be replaced by the end of 2021 – these included EURIBOR, LIBOR and EONIA. All interest-linked products such as variable-rate securities, loans and derivatives are affected by a change in the benchmarks.

Central banks and supervisory authorities are calling for sustainability risks to be taken into
account in banks‘ risk management and in monitoring financial market stability. This means
that banks are required to systematically take ESG (Environment / Social / Governance) risks
into account when aligning their business models in their organizational structures, as well
as continuously recording and managing ESG risks and their effects on capital / earnings and
liquidity.
The new EBA action plan (EBA „Discussion Paper on Management and Supervision of ESG
Risks for Credit Institutions“ January 2021) and the corresponding ECB guidelines („Guide
on climate related and environmental risks“ November 2020) are clear signs that the current
focus of supervision is on managing ESG risks.

We now have a special issue for you:

• This booklet with 8 of the most important interest risk strategies
• A link to the i28 Interest Risk Simulation in order to apply ALM interest risk strategies in practice
• An “i28 Proof of Achievement” at the end of the i28 Tutorial to prove your strategy knowledge

In CRR II, the Commission is making the specification of the requirements for the NSFR. After the proposal was approved by the Council on June 7th, 2019 (EU 2019/876) and the new provisions become mandatory two years after its adoption, the standard will be mandatory for banks to report and comply with from July 2021. It should be noted that this is an EU regula-
tion and therefore, this period applies directly in all member states.

In this article, we would like to deal with the amount of additional costs in the calculation led by the NSFR and present appropriate approaches.

On 19 July 2018, the EBA adopted its final guidelines on minimum interest rate risk management standards in the banking book („Guidelines for the Management of Interest Rate Risk arising from non-trading book positions“ EBA/GL/2018/2). In this article we want to focus on the impact of interest options and the methods for taking into account implicit and explicit options in the risk measurement. Doing so, it is possible to clarify – with respect of prudential supervision – the amount by which interest rate option increase or reduce the risk in the banking book and, if so, redefine the bank‘s interest rate risk strategy.

On 19 July 2018, the EBA adopted its final guidelines on minimum standards for interest rate risk management published in the banking book („Guidelines for the Management of Interest Rate Risk arising from non-trading book positions“ EBA/GL/2018/2).

In this article, we will try to give an overview of the requirements that the IRRBB implementation 2019 entails.

Interest rate risk management in Asset Liability Management / ALM – is it worth the effort? Does the interest rate risk have a significant effect on the bank‘s earnings? The supervisor says YES – intensifies the regulations and warns against rising interest rates. We also say YES – because every risk has also a potential to improve profits. In this article, we try to quantify the earnings potential of a (conservative) interest rate risk management and we describe the prerequisites and resources for raising the potentials.

The ECB has published its ICAAP consultation guide and urges for implementation: the guide will be finalized in the second half of 2018 and enforced in 2019 already as the basis of the banks’ SREP assessment. Thus, the banks must implement it in 2018.

This also means the consideration of future legal projects within the ICAAP planning and in the stress case analysis. Conclusion: Control in the 99% confidence interval is long history and the Basel 3 maxim „Control under stress“ is replaced by „Control under stress – today and in the future“.

In order to increase security in equity and debt capital planning, the banking sector has been waiting for a long time for concrete implementation proposals for the MREL specifications. As usual, Basel (here with the corresponding TLAC specifications) sets the direction.

In May 2016 the EU Regulation EU 2016/1450 sets the framewor for the Minimum Requirements for Eligible Liabilities (MRELs), yet the MREL ratio – to be fixed invidually per bank – is still missing for most institutions.

In the current edition of the ALM Forum we give an overview of the concept and the dimension of the MREL requirements and analyze the consequences in the equity and debt capital planning for different types of banks.

Once the CRR2 regulations are enforced, banks will have to realign their investment in funds completely. Reasons are the new capital adequacy rules for funds (Article 132 CRR2) and the new regulation for the separation of the banking and trading book (Article 104 CRR2). The Regulation follows two principles: individual exposures must be identifiable (Look Through) and investment funds may not replace an outsourced trading book.

The EU-Commission published its final proposal for the implementation of the still unaddressed Basel III Net Stable Funding Ratio (NSFR) on 23rd of November 2016. Since credit institutions lack sufficient experience in NSFR-management it is of crucial importance for them to introduce a working mechanism prior to the compulsory deadline. Moreover, in contrast to the LCR the NSFR does not allow last-minute correction measures in order to satisfy the minimum requirements.

Rather the NSFR-Ratio leads to a medium- and long-term restructuring of the balance sheet with a potential impact on the business model. This renders the NSFR a more relevant liquidity requirement from a corporate management perspective than the short-term LCR. Our ALM Forum No. 18 provides an overview of the current European implementation requirements and the respective deviations from the Basel standards.

The compliance with the Basel 3 requirements on equity, liquidity and disclosure, entering into force between 2016 and 2019, will constitute a major challenge for banks. The changing regulatory framework influences strategies for the Asset Liability Management (ALM) both directly and indirectly, which makes it essential to keep an eye on the content and implementation schedule. The aim of our December 2016 issue of the ALM Forum is, therefore, to provide an overview regarding the content and status of implementation.

IFRS 9 results in changes for the calculation of Value Adjustments from 1st January 2018. Additionally, the Basel Committee of Banking Supervision (BCBS) has set the framework for the new standard’s implementation in the banking sector with its “Guidance on credit risk and accounting for expected losses” in December 2015. These changes will have a significant impact on future profit and loss statements, equity, credit risk assessments and the systemic requirements for banks.

Our ALM Forum provides an overview of the changes together with an example of the impact on profit and losses and concludes with consequences for banks.

Today we are presenting the standard approach for the calculation of the credit spread risk within the ICAAP. It is derived from the BIS standards for the measurements of market risks in the trading book.

Please let us know whether the results of the example porfolio within this paper meet your observations in practise.

In January 2016 the BIS published its final standards for the new capital requirements regarding market risk in the trading book.

• The new allocation criteria for trading and banking book positions can lead to an increased trading book.
• Additional pressure arises to book hedging positions under the IFRS Hedge Accounting standards.
• A new standard approach for measuring Credit Spread Risk, which has the potential to become the standard for Credit Spread Risk measurement.

When managing the banking book, the committee structure represents the usual form of implementation regarding the organisational structure. An essential decision authority goes along with the committees, which has to be clearly structured.

Considering Asset-Liability-Management and Total Bank Management as individual entities is a crucial point in this discussion, since these terms are usually used synonymously. In an all-encompassing approach these terms depict different target-topics.

In recent years regulatory requirements regarding risk measurement approaches have been tightened in almost all risk categories. Interest rate risks within the banking book, however, remained untouched until now. In order to make interest risk in the banking book more transparent and internationally comparable, EBA has published the “Guidelines on the management of Interest rate risk arising from non-trading activities” in May 2015. The standard introduces new regulations for the interest rate risk in the banking book. All banks in the EU have to implement these Guidelines by 01.01.2016.

A highly interesting topic – especially for banks where the interest gap contribution of the banking book is a substantial part of the net interest income.

What does “Fully Loaded” mean in the context of the continually increasing capital requirements for the individual bank? This question has to be clarified by the bank management taking into account all currently known and expected regulations. The task of ALM – the overall bank management – will be to steer the bank consistently with the agreed goal. In the current issue of the ALM Forum we provide a comprehensive overview on the subject “expected capital requirements” as well as arguments for the goals.

The changes in the LCR calibration impose a re-designing of the liquidity strategies in the banks. Our article concretely describes the most important changes in the final LCR regulation.

Especially the calculation of the LCR Ratio has become more complex due to multiple constraints introduced. In our article we show an example of the calculation of the recognised high liquid assets – the current regulation will be introduced in our ALM decision trainings and ALM Update Workshops in spring 2015.

Both the intensified use of collaterals (repos, covered bonds, ECB refinancing, margins with derivatives) as well as the priority ranking of state-guaranteed retail deposits in the new EU resolution regime lead to shrinking volumes of assets available to cover unsecured funds in case of liquidation. Therefore, banks (and the ALM) have to start to actively manage the asset encumbrance. In this article we will present and discuss the different alternatives available for calculating the asset encumbrance of banks.

The different valuation methods of banking book positions are resulting in undesired fluctuations of the P&L result. IAS 39 provided a framework (hedge accounting) to deal with and offset these P&L result fluctuations. However, the strict rules for hedge accounting often limited the implementation of appropriate hedging strategies. With the new standard IFRS 9, the points of critics of the industry has been taken into account, trying to make the framework of hedge accounting more practical. Especially, the risk management strategy has become more important and is assigned a key factor in IFRS 9 hedge accounting. The following article tries to gives an overview of the most remarkable changes of IFRS 9 compared to IAS 39.

The increasing credit spread volatility as a result of increasing bond portfolios at banks requires the quantification of credit spread risk to avoid undesired effects in the P&L result. For that purpose it is necessary to separate the credit spread risk from the interest risk position of the bond, to recognize term-time valuation results in the P&L in a clean manner and to measure credit spread risk (on a portfolio basis). The article presents methods of credit spread calculation as well as the reconciliation of the credit spread risk result with the P&L result.

Using different interest rate curves in customer business and ALM/risk management may lead to “management mistakes” as well as adverse effects on the bank result. Another issue are the liquidity costs of the pool banks contained in the EURIBOR/LIBOR rates, which make it impossible to cleanly calculate and manage interest and liquidity risk. The solution is to price the basis swap costs of the individual basis interest curves into the corresponding products and to adopt the EONIA swap curve as interest transfer price. The article deals with these bank management issues and shows a workable solution illustrated with calculation examples.

The management of liquidity risk and the necessary allocation of liquidity costs has gained in importance since the financial crisis – not only due to new regulatory requirements, but also from an economic point of view in bank management. Besides the calculation of the stress capital commitment, this requires the transparent derivation of the liquidity curve, allowing ALM to manage liquidity risk and to allocate liquidity costs to their respective causes. The article gives an overview on the requirements, the result-neutral calculation as well as the influencing factors for allocating liquidity costs.

Interest and liquidity risk management of the banking book by ALM are especially challenging for non-bullet loans or deposits. Using the simple average of reference rates results in undesired customer margin volatilities, due to constant capital repayment until maturity. This drawback may be avoided by using term weighted tranches/reference rates. The article gives an overview of the two approaches of transfer price calculation including the corresponding advantages and disadvantages. Finally, the impact on the customer business and ALM result is presented.

In a transfer price system, margin stability in the customer business is crucial. This requires risk positions (interest, liquidity) to be manageable by ALM. Using “dirty” transfer price models for managing positions without contractually defined maturity affecting income, may result in substantial problems in hedging and fluctuations of the bank result.

The article gives an overview of the different options for dynamic management using moving average rates, with a special focus on handling volume increases and decreases. Additionally, the advantages/disadvantages of the different methods are described as well as their influence on the customer margin and interest gap contribution.

Setting up a “sound” capital commitment balance is a very important issue in a bank’s current bank management/ALM and governance/compliance. Based on the capital commitment balance, the bank manages the pricing of the customer business (liquidity costs) and the liquidity in ALM; measures the refinancing risk (necessary liquidity buffer) and calculates the liquidity cost risk (ICAAP). Therefore, the board has to make sure that the method employed is accepted throughout the bank, and also vouch for it in front of the regulator.

How to deal with fixed, clearly defined capital commitments is not the issue at hand. Rather, it is the many products without a (clearly) defined term, with multiple clauses and options, with collaterals and requirements as well as the validation requirements in a normal as well as stress case the treatment of which has to be clarified. Our article outlines the currently available methods for modelling capital commitments which would then have to be adapted to the individual product portfolio of each bank.

Products with undefined interest and capital commitment are frequently found in European universal banks’ product portfolios and the margin on these products is a major source of net interest income. Managing these products and the resulting interest risk position depends on a professional method of transfer pricing which is becoming more and more important due to several reasons:

• Growing competition of banks for saving deposits due to expected regulatory requirements (e.g. LCR/NSFR) and the debt crisis, whereby pricing becomes a major factor of competition
• Pressure of regulator on banks to sufficiently validate interest and capital commitment assumptions