Recalibration of IRRBB interest rate shocks – BCBS has published the final paper

Abstract

This article describes the final paper published by the Basel Committee on July 16, 2024 following a consultation phase on the recalibration of IRRBB interest rate shocks¹. It deals with both the proposed methodological adjustments and the results of the recalibration.

Background

In April 2016, the Basel Committee published a fundamentally revised version of its IRRBB guidelines². This document contained the definition and calibration of six currency-dependent interest rate shock scenarios for the first time.

These scenarios, standardized by the supervisory authority, depict both parallel shifts and twists in the yield curve for the 21 most important currencies worldwide. In subsequent years, they were adopted by many regulators worldwide in the requirements for measuring interest rate risk in the banking book (IRRBB), including the EBA and all national supervisory authorities in the EU. In 2018, the EBA added parameters for seven other European currencies to the Basel requirements.

All banks in the EU must regularly calculate the impact of these scenarios on their interest rate risk positions for the major currencies in their banking book. They must use the new IRRBB regulatory reporting template to report the results of the risk simulations for all six scenarios in the economic perspective³ and for the two parallel scenarios in the earnings-oriented perspective⁴ to the supervisory authority on a quarterly basis.

Interest rate shock parameters

The six IRRBB interest rate scenarios for each currency are derived from the three parameters “parallel”, “short rate” and “long rate”, which can be used to calculate the interest rate scenarios “parallel shock up”, “parallel shock down”, “steepener shock”, “flattener shock”, “short rates shock up” and “short rates shock down” for all maturities of an interest rate curve on the basis of simple predefined formulas.

These three parameters were derived by the Basel Committee for each currency from an interest rate history of 16 years from the beginning of 2000 to the end of 2015. The Basel Committee already emphasized in 2016 that it would regularly review the IRRBB scenarios.

Methodological adjustments

For the first-time recalibration of the IRRBB scenarios, the Basel Committee published a final version of a paper on July 16, 2024 after a consultation phase in which it proposes a modified method for calculating the parameters for the interest rate scenarios. The proposed changes essentially relate to four aspects:

1. The time series under consideration has been extended from 16 to 24 years and now covers the period from the beginning of 2000 to the end of 2023⁵.
2. The parameters are determined on the basis of absolute interest rate changes and no longer on the basis of relative interest rate changes.
3. They are derived from a 99.9 % quantile and no longer from a 99.0 % quantile.
4. The calculated shock parameters are applied individually for each currency, whereas previously they were converted into global cross-currency factors.

The new methodology can be outlined as follows:

• On the extended interest rate history with daily interest rates from January 3, 2000 to December 29, 2023, the absolute interest rate changes to be observed over a period of 6 months (125 trading days) are calculated for nine maturities⁶ for each currency under consideration.
• Mean values are calculated for these interest rate changes observed on a daily basis over a moving 6-month time window: for “short rate” over the terms of 3 months, 6 months and 1 year, for “long rate” over the terms of 10 years, 15 years and 20 years and for “parallel” over all nine terms under consideration.
• In the next step, the absolute values are calculated for each of the resulting three time series of interest rate averages (relating to “short rate”, “long rate” and “parallel”) and then the 99.9 % quantiles are calculated.
• A floor of 100 BP (basis points) and a cap of 500 BP for “short rate”, 300 BP for “long rate” and 400 BP for “parallel” are applied to the results.
• Finally, the resulting values are rounded to the nearest multiple of 25 bp⁷.

Key features of the new methodology are the extension of the interest rate history under consideration from the beginning of 2000 to the end of 2023, the use of absolute interest rate changes on a moving 6-month time frame and the 99.9% quantile for deriving the risk parameters.

In the author’s view, the Basel Committee’s approach to calibrating the IRRBB interest rate shocks can also serve as a model for in-house risk measurement procedures or as a useful argumentation aid in the annual parameter validation.

Results of the recalibration

The recalibrated parameters deteriorate (increase) in a good 40 % of the 63 cases considered compared with the previous parameters. For the euro, the recalibration results in an increase in all three cases:

With the new parameters, the parallel shifts for the euro become somewhat stronger, the short swings in the short rate shocks significantly larger and the twists in the steepener and flattener shocks significantly stronger.

A deterioration in all three cases also results for the British pound and the Swiss franc.

On the other hand, the US dollar has barely changed:

The EBA’s detailed analysis shows that the effects result both from the changed calculation method and from the extension of the interest rate history.

msg for banking developed an Excel-based tool for calculating the IRRBB scenarios in accordance with the regulatory requirements back in 2017. This tool has been expanded to include the final recalibrated parameters. It is available to download free of charge⁸. Institutions can use it to simulate the effects of a future recalibration on their key risk figures now using the interest rate scenarios generated.

Conclusion and outlook

The recalibration of the IRRBB interest rate shocks, in particular the extension of the interest rate history and the adjustment of the methodology, were overdue in light of the significant interest rate developments since the end of 2015. The Basel Committee has now published a revised standard in line with the times. It is due to come into force on January 1, 2026. It can be assumed that the EBA and other supervisory bodies worldwide will adopt this standard over the next few years, so that the recalibrated IRRBB interest rate shocks will replace the previous ones.

From the author’s point of view, the recalibrated scenarios reflect the interest rate risk situation for each currency more realistically than the previous ones. For this reason, a regular simulation of their effects on the key risk figures, in particular the IRRBB outlier criteria, is already recommended – in parallel to the currently valid IRRBB interest rate scenarios.