Basel Committee performs U-turn on interest rate risk capital charge, but key challenges remain for banks on risk management and disclosure requirements
Yesterday, the Basel Committee announced it would not implement its proposals to require a mandatory pillar 1 capital charge for banks on interest rate risk. The proposals, originally announced last year in the IRRBB consultative document, which included a 15% standardised charge to cover the impact of interest rate changes on their balance sheets (a requirement that encountered fierce opposition and was widely seen as ridiculous by the banking community) will now not go ahead.
While this U-turn is certainly good news for bankers, it is perhaps not a cause for total celebration given the Committee has said it will still go ahead on proposals for stricter disclosure requirements for bank exposures under pillar 2. These new IRRBB standards certainly seek to address the ‘nuts and bolts’ of how banks manage interest risk. These new standards are also seen as ‘pertinent’ by the Committee in light of the current exceptionally low interest rates in many jurisdictions.
The Basel Committee’s original ‘Principles’ for the management and supervision of interest rate risk was published in 2004 and sought to address some of the pitfalls of a regulatory regime which had failed to prevent the Savings and Loan Crisis of the 1980s and 1990s, where regulators had to resolve over a third of all saving and loan institutions in the US. These new updated standards will require banks under pillars 2 and 3 to identify and report risks such as behavioural risks (including prepayments and withdrawals), yield curve calibrations and impact on net interest income. This, combined with the stress testing, will unequivocally enable a much more comprehensive assessment of interest risk embedded on banks’ balance sheets.
Despite the additional regulatory burden for the industry, it could be argued that these new rules represent progress and provide shareholders with a far better view of the risks usually hidden through accrual accounting methodology. Moreover, a stronger framework for the disclosure, identification and assessment of these risks should strengthen trust in the banking system. Indeed, this could be regarded a good victory for risk management!