Response to consultation on draft RTS on IRRBB standardised approach
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Prepayment on floating-rate loans, typically, is possible without a penalty only when the benchmark index reprices. Consequently, the impact on EVE of prepayments on such instruments is negligible if at all existent. EAPB, therefore, does not see any need for a requirement in Article 6 for institutions to estimate prepayments for these instruments .
● EAPB asks EBA to clarify the perimeter of article 7, paragraph 12.
Promotional and public banks provide financial services and funding for projects that support sustainable economic and social development. Such banks may primarily or even exclusively have non-financial customers. Deposits from such customers may mainly be wholesale deposits.
Banks may provide only non-maturity wholesale deposits for operational reasons to its customers that are, with few exceptions, non-financial. These deposits will be core to the bank’s business model. The perimeter defined in article 7, paragraph 2, does not extend to such deposits. Consequently, article 7, paragraphs 3 to 11 would not apply to those deposits.
The single wholesale deposit for operational reasons to a financial customer, primarily, may serve as a credit-risk mitigation. Identification of stable, non-stable, core, or non-core element is irrelevant for the banks. Applying article 7 to this deposit would ignore its purpose, resulting in incorrect treatment of that particular wholesale deposit of a financial customer.
Article 7, paragraph 12 requires banks to identify non-maturity deposits as non-core deposits if they amount to less than 2% of relevant liabilities. Alternatively, if they amount to more than 2% of relevant liabilities, no such classification applies. Paragraph 12, however, is the only paragraph that does not explicitly excludes wholesale deposits of non-financial customers.
Information technology allows for institutions to project cash flow schedules using actual maturities and tenures of instruments. The use of maturity and repricing buckets, likely, requires banks to implement a cash flow model for the sole purpose of performing the supervisory shock scenarios that is cumbersome, does not correspond to their administration, and is inaccurate.
● EAPB would like to draw EBA’s attention to the possibility that prepayments may induce penalty payments compensating the issuer for the loss in economic value or interest income. Article 8, paragraph 5 does not consider this possibility. The unconditional bucketing of expected prepayments, therefore, could add an error to the aforementioned inaccuracy.
● banks’ exposure to retail counterparties may be limited to indirect exposures as meant in article 8, paragraph 7. Behavioural options would include take-up rates on offered loans for which there is limited reason to expect significant sensitivity to interest-rate movements. Consequently, we do not expect this to be a relevant issue for banks.
● EAPB requests EBA to clarify whether article 12 extends to embedded and explicit automatic options where the latter fully and effectively hedges the former; or, whether such hedged positions can be treated on a netted basis.
An Institution may hold or issue instruments that hold embedded options unique to the instrument. If the institution hedges the embedded option with an explicit option that may be unique and neither have a pricing history, nor have substitute for which the institution can observe prices. Unless institutions may net fully and effectively hedged automatic options embedded in their instruments with explicit options, article 12 would involve modelling options for which no data can be observed that allow institutions to derive implicit volatilities for the purpose of shocking these. Consequently, article 12 would not be ‘operationally implementable.’
● EAPB considers Article 13 not ‘operationally implementable.’
Information technology allows for institutions to project cash flow schedules using actual maturities and tenures of instruments. Article 13 requires institutions to develop an artificial cash-flow schedule for the purpose of applying the standardised approach where it has in place a model that generates the exact schedule for cash flows. The slotting of cash flows into maturity buckets creates an inaccurate projection for the management of the Bank’s liquidity position. The standardised approach would thus be unsuitable for internal management purposes. A preferable approach would be to build on the more accurate model if the institution has implemented such.
Promotional and public banks provide financial services and funding for projects that support sustainable economic and social development. They offer loans tailored for the needs of individual clients and commit long term to their clients. Consequently, the banking books of promotional and public banks will hold loans for which there are no deep and liquid markets. Furthermore, commercial margins and spreads, generally, will reflect the banks’ missions and not the interest rate environment.
Most accounting regimes require institutions to carry traded and over-the-counter (OTC) derivatives at ‘fair value.’ Promotional and public banks, by the nature of their business, may carry large parts of their assets and liabilities at amortised cost. They can hedge their exposures and apply hedge accounting to offset the change in the fair value of the hedging instrument. Hedge accounting does not reclassify the hedged instrument as ‘fair value’ instrument.
Article 20 requires institutions to calculate an add-on for instruments held at fair value. These include the hedge instruments, but, not necessarily, the hedged instruments. The asymmetric treatment of the hedge instrument and hedged instrument in articles 15 and 20 causes spurious outcomes for the NII measure of IRRBB.
In the explanatory box following article 20, EBA states ‘Since the fair value of instruments tends to return to their face value at maturity, Article 20 only focuses on fair value instruments that mature beyond the horizon for the calculation of net interest income.’ Hedge accounting allows institutions to adjust for that same characteristic of derivatives maturing beyond the horizon used to hedge instruments not carried at fair value.
● EAPB considers the calculation of the net interest income add-on for basis risk not ‘operationally implementable.’
In a concurrent consultation, EBA suggests the competent authority imposes a standardised approach on an institution that has an inadequate internal system for the management of IRRBB. EBA further imposes artificial slotting of cash flows into maturity buckets to facilitate calculations. Yet, EBA requires institutions that have an inadequate internal system for the management of IRRBB to be equipped to model conditional widening and narrowing of spreads between basic rates. The explanatory box, further, adds institutions should do so conditional on the interest rate environment without defining such.
A change in basic rates impacts the fair value of interest derivatives that mature beyond the horizon and are fair-value instruments. Asymmetric treatment of the hedge instrument and hedged instrument causes spurious outcomes for the NII measure of IRRBB.
Question 1: What is the materiality of prepayments for floating rate instruments and what are the underlying factors? Would you prefer the inclusion of a requirement in Article 6 for institutions to estimate prepayments for these instruments?
We respond EBA with reference to Question 1 as follows.Prepayment on floating-rate loans, typically, is possible without a penalty only when the benchmark index reprices. Consequently, the impact on EVE of prepayments on such instruments is negligible if at all existent. EAPB, therefore, does not see any need for a requirement in Article 6 for institutions to estimate prepayments for these instruments .
Question 2: Do respondents find that the required determination of stable/non-stable deposits, and core/non-core deposits as described in Article 7 is reflective of the risks and operationally implementable? In case of any unintended consequence or undesirable effect on certain business models or specific activities, please kindly provide concrete examples.
We respond EBA with reference to Question 2 as follows.● EAPB asks EBA to clarify the perimeter of article 7, paragraph 12.
Promotional and public banks provide financial services and funding for projects that support sustainable economic and social development. Such banks may primarily or even exclusively have non-financial customers. Deposits from such customers may mainly be wholesale deposits.
Banks may provide only non-maturity wholesale deposits for operational reasons to its customers that are, with few exceptions, non-financial. These deposits will be core to the bank’s business model. The perimeter defined in article 7, paragraph 2, does not extend to such deposits. Consequently, article 7, paragraphs 3 to 11 would not apply to those deposits.
The single wholesale deposit for operational reasons to a financial customer, primarily, may serve as a credit-risk mitigation. Identification of stable, non-stable, core, or non-core element is irrelevant for the banks. Applying article 7 to this deposit would ignore its purpose, resulting in incorrect treatment of that particular wholesale deposit of a financial customer.
Article 7, paragraph 12 requires banks to identify non-maturity deposits as non-core deposits if they amount to less than 2% of relevant liabilities. Alternatively, if they amount to more than 2% of relevant liabilities, no such classification applies. Paragraph 12, however, is the only paragraph that does not explicitly excludes wholesale deposits of non-financial customers.
Question 3: Do respondents find that the required determination and application of a conditional prepayment rate and term deposit redemption rate as described in Article 8 and 9 is reflective of the risks and operationally implementable? In case of any unintended consequence or undesirable effect on certain business models or specific activities, please kindly provide concrete examples.
We respond EBA with reference to Question 3 as follows.Information technology allows for institutions to project cash flow schedules using actual maturities and tenures of instruments. The use of maturity and repricing buckets, likely, requires banks to implement a cash flow model for the sole purpose of performing the supervisory shock scenarios that is cumbersome, does not correspond to their administration, and is inaccurate.
● EAPB would like to draw EBA’s attention to the possibility that prepayments may induce penalty payments compensating the issuer for the loss in economic value or interest income. Article 8, paragraph 5 does not consider this possibility. The unconditional bucketing of expected prepayments, therefore, could add an error to the aforementioned inaccuracy.
Question 4: Is the treatment of fixed rate loan commitments to retail counterparties clear and are there other instruments with retail counterparties where a behavioural approach to optionality should be taken?
We respond EBA with reference to Question 4 as follows.● banks’ exposure to retail counterparties may be limited to indirect exposures as meant in article 8, paragraph 7. Behavioural options would include take-up rates on offered loans for which there is limited reason to expect significant sensitivity to interest-rate movements. Consequently, we do not expect this to be a relevant issue for banks.
Question 5: Do respondents find that the required determination of the impact of a 25% increase in implicit volatility as described in Article 12 is operationally implementable?
We respond EBA with reference to Question 5 as follows.● EAPB requests EBA to clarify whether article 12 extends to embedded and explicit automatic options where the latter fully and effectively hedges the former; or, whether such hedged positions can be treated on a netted basis.
An Institution may hold or issue instruments that hold embedded options unique to the instrument. If the institution hedges the embedded option with an explicit option that may be unique and neither have a pricing history, nor have substitute for which the institution can observe prices. Unless institutions may net fully and effectively hedged automatic options embedded in their instruments with explicit options, article 12 would involve modelling options for which no data can be observed that allow institutions to derive implicit volatilities for the purpose of shocking these. Consequently, article 12 would not be ‘operationally implementable.’
Question 6: Do respondents find that the required slotting of repricing cash flows in accordance with the second dimension of original maturity/reference term as described in Article 13 is operationally implementable?
We respond EBA with reference to Question 6 as follows.● EAPB considers Article 13 not ‘operationally implementable.’
Information technology allows for institutions to project cash flow schedules using actual maturities and tenures of instruments. Article 13 requires institutions to develop an artificial cash-flow schedule for the purpose of applying the standardised approach where it has in place a model that generates the exact schedule for cash flows. The slotting of cash flows into maturity buckets creates an inaccurate projection for the management of the Bank’s liquidity position. The standardised approach would thus be unsuitable for internal management purposes. A preferable approach would be to build on the more accurate model if the institution has implemented such.
Question 7: Do respondents find it practical how the determination of several components of the NII calculation, with in particular the fair value component of Article 20 and the fair value component of automatic options of Article 15, is generally based on the processes used for the EVE calculation (in particular Article 16 and Article 12)?
● It is the EAPB’ s opinion the determination of fair value components of NII results in spurious outcomes for NII sensitivity to IRRBB.Promotional and public banks provide financial services and funding for projects that support sustainable economic and social development. They offer loans tailored for the needs of individual clients and commit long term to their clients. Consequently, the banking books of promotional and public banks will hold loans for which there are no deep and liquid markets. Furthermore, commercial margins and spreads, generally, will reflect the banks’ missions and not the interest rate environment.
Most accounting regimes require institutions to carry traded and over-the-counter (OTC) derivatives at ‘fair value.’ Promotional and public banks, by the nature of their business, may carry large parts of their assets and liabilities at amortised cost. They can hedge their exposures and apply hedge accounting to offset the change in the fair value of the hedging instrument. Hedge accounting does not reclassify the hedged instrument as ‘fair value’ instrument.
Article 20 requires institutions to calculate an add-on for instruments held at fair value. These include the hedge instruments, but, not necessarily, the hedged instruments. The asymmetric treatment of the hedge instrument and hedged instrument in articles 15 and 20 causes spurious outcomes for the NII measure of IRRBB.
In the explanatory box following article 20, EBA states ‘Since the fair value of instruments tends to return to their face value at maturity, Article 20 only focuses on fair value instruments that mature beyond the horizon for the calculation of net interest income.’ Hedge accounting allows institutions to adjust for that same characteristic of derivatives maturing beyond the horizon used to hedge instruments not carried at fair value.
Question 8: Do respondents find that the calculation of the net interest income add-on for basis risk is reflective of the risk and operationally implementable
We respond EBA with reference to Question 8 as follows.● EAPB considers the calculation of the net interest income add-on for basis risk not ‘operationally implementable.’
In a concurrent consultation, EBA suggests the competent authority imposes a standardised approach on an institution that has an inadequate internal system for the management of IRRBB. EBA further imposes artificial slotting of cash flows into maturity buckets to facilitate calculations. Yet, EBA requires institutions that have an inadequate internal system for the management of IRRBB to be equipped to model conditional widening and narrowing of spreads between basic rates. The explanatory box, further, adds institutions should do so conditional on the interest rate environment without defining such.
A change in basic rates impacts the fair value of interest derivatives that mature beyond the horizon and are fair-value instruments. Asymmetric treatment of the hedge instrument and hedged instrument causes spurious outcomes for the NII measure of IRRBB.
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