1 Guidance on the management of interest rate risk arising from nontrading activities Introduction 1. These Guidelines refer to the application of the Supervisory Review Process under Pillar 2 to a structured dialogue between the BNB and banks that should embrace four types of risks: - Pillar 1 risks; - risks not fully captured under Pillar 1; - risks, covered by Pillar 2; - external factors not already considered in the previous cases. 2. According to Regulation No. 8 of the BNB on the capital adequacy of credit institutions (Regulation No. 8), banks should develop and maintain an ICAAP that identifies risks they are or might be exposed to and allocate adequate financial resources against those risks. 3. This paper sets out technical guidelines applicable to one of those risks: interest rate risk arising from non-trading activities (here interest rate risk in the banking book or IRRBB ). 4. The document puts the emphasis on high-level guidance, addressed to banks and some to supervisors. It is not meant to provide detailed guidance on whether and how quantitative tools and models should be used or developed. The responsibility for this must rest with the bank, though the BNB will expect to see banks develop their own systems and stress tests which are commensurate with their risk profile and risk management policies. 5. It sets out general considerations including current international thinking, a definition of what the IRRBB should cover, the relevant legal requirements of Law on credit institutions (LCI) and Regulation No. 8. It is recognized that market practices and supervisory approaches may evolve over time, and therefore there is a need to ensure that such a technical paper is kept under review and, to the extent necessary, adapted to reflect any such developments. 6. The concept of proportionality, (Article 79, paragraph 3 of LCI) also underlined in the introductory statements of the Guidelines on the application of the supervisory review process, applies also to IRRBB measurement and management, the complexity of which will be expected to be related to the size of the banks as well as to the sophistication and diversification of their activities. 7. The paper sets out: A) Guidance on what the BNB should expect to see in the ICAAP, under which it is the bank s own responsibility to manage adequately (i.e. identify, measure and control) these risks and allocate internal capital, where considered necessary, in support of the interest rate risk in a structured manner; B) The way, the BNB conducts the Supervisory Review Process and Evaluation Process in relation to the ICAAP. BNB will require banks to show that their internal capital, where considered necessary, is commensurate with the level of the interest rate risk in the banking book. BNB will adapt own approach to ensure
2 2 it is proportionate to the nature, scale and complexity of the activities of a bank. Similarly, the depth, frequency and intensity of the evaluation of the BNB will be determined by the risks posed to the BNB s statutory objective of ensuring the soundness of the banking sector. 8. According to Article 103, paragraph 1, item 11 of LCI, in cases where an institution s economic value declines by more than 20% of own funds as a result of a standard shock, the BNB may apply the measures under paragraph 2 of the same Article. As the Directive 2006/48/EC do not define what that standard shock should be, CEBS proposes a common definition. This is intended to achieve a common standard which supervisors can apply consistently across the EU, there by delivering a level playing field. 9. This would enable banking groups operating on a cross border basis to calculate the standard shock in a comparable way. If necessary, the BNB can set a shock of a different magnitude than the one delivered by the calculation method of IRRBB 5. BNB as a consolidating supervisor coordinates the dialogue with other supervisory authorities, regarding the cross-border banking and investment firm groups, according to the guidelines of CEBS on supervisory cooperation. Where the BNB is not such an authority, it should participate in this dialogue in order to achieve consistency of the shocks applied. 10. BNB acknowledges the broad brush nature of a standard shock and recognizes that, as part of its dialoque with individual banks, may require banks to apply shocks of a different order of magnitude, both in amount and time, reflecting the nature, size and complexity of the banks. Used acronyms IRRBB- Interest rate risk in the banking book; IRRBB Interest rate risk in the banking book from 1 to 9 Principles, regarding the interest rate risk in the banking book. Chapter 1 General considerations 1. The measurement of interest rate risk in the banking book in a non-mark-tomarket world poses a number of major practical difficulties. Most of those difficulties are dealt with by banks making certain assumptions which may differ between banks and which may be modified over time even within one bank. Hence interest rate risk in the banking book is part of Pillar 2 where a tailored approach is possible. 2. Some issues, such as the consequences of IFRS use for the reporting and management of interest rate risk, have not been captured in the present document but may be the subject of further work by CEBS and BNB in due course. 3. Under the IFRS framework, the fair value option in IAS 39 will allow banks to fair value banking book items, and as a result the banks will increase the use of fair value rather than historical cost for the measurement of a number of financial assets (including derivatives) held in the banking book and eventually some of their liabilities.
3 3 IFRS additionally asks bank to perform and disclose a sensitivity analysis for each of the market risks to which they are exposed, including the interest rate risk on financial instruments. The disclosure could take a number of forms, such as a maturity-reporting schedule. Financial risk management policies and objectives must also be disclosed. There will clearly be some differences with the regulatory framework for interest rate risk in the banking book, because the objectives of prudential regulation and IFRS, and some of the definitions used, will not be the same in all cases International context 4. This paper is consistent with current international thinking about interest rate risk in the banking book. The following documents form the basis for these guidelines: - Basel Committee on Banking Supervision s revised framework on International Convergence of Capital Measurement and Capital Standards (June 2004) ( the Basel text ). In particular Section III, paragraphs ; - Supporting Document to the Capital Adequacy Framework, deal with interest rate risk (in both the banking and the trading book) - Principles for the Management and Supervision of Interest Rate Risk, July 2004; - Guidance on qualitative aspects of the management and application of the supervisory review process under Pillar 2 (Chapter 2.1 Guidelines on Internal Governance) Definition for interest rate risk 5. For the purpose of this paper, interest rate risk is taken to be the current or prospective risk to both the earnings and the capital of banks arising from adverse movements in interest rates. In the context of Pillar 2, this is in respect of the banking book only, given that interest rate risk in the trading book is already covered under the Pillar 1 market risk requirements. 6. Consideration of interest rate risk from the perspectives of both short-term earnings and economic value is important. Volatility of earnings is an important focal point for interest rate analysis because significantly reduced earnings can pose a threat to capital adequacy. However, measurement of the impact on economic value (the present value of the bank s expected net cash flows) provides a more comprehensive view of the potential long term effects on a bank s overall exposures. Therefore, the supervisory focus will primarily be on measuring interest rate risk in relation to economic value. However, and subject to proportionality considerations, banks are also expected to consider interest rate risk in relation to earnings as a supplementary measure Legal basis 7. Interest rate risk in the banking book is treated under the ICAAP/SREP framework. Similar to other Pillar 2 risks, LCI and Regulation No. 8 require that: a bank shall implement systems to evaluate and manage the risk arising from potential changes in interest rates as they affect a bank s non-trading activities (Article 12, paragraph 3 of Regulation No.8);
4 4 banks shall have in place sound, effective and complete strategies and processes to assess and maintain on an on-going basis the amounts, types and distribution of internal capital that they consider adequate to cover the nature and level of the risks to which they are or might be exposed (Article 11, paragraphs 2-3 of Regulation No. 8); BNB have to review risk management processes and capital adequacy (Article 79, paragraphs 1-3 of LCI). 8. According to Article 103, paragraph 1, item 11 of LCI, the BNB has to take action in cases, where the economic value of a bank declines by more than 20% of own funds as a result of applying supervisory standard shock to its interest rate risk in the non-trading book Current market practices I. Identification of IRRBB 9. There are numerous ways that banks currently use to identify and measure IRRBB. Their methods reflect the specific form of the risk in question and the nature, scale and complexity of their activities. IRRBB encompasses: a) risks related to the timing mismatch in the maturity and repricing of assets and liabilities and off balance sheet short and long term positions (repricing risk); b) risk arising from changes in the shape of the yield curve (yield curve risk); c) risks arising from hedging exposure to one interest rate with exposure to a rate which reprices under slightly different conditions (basis risk); and d) risks arising from options, including embedded options, e.g. consumers redeeming fixed rate products when market rates change (i.e. option risk). II Monitoring and management of IRRBB 10. A wide range of tools may be used by banks to measure and monitor IRRBB. The choice of monitoring system and management techniques used is determined by the banks management to be most appropriate depending on the nature, scale and complexity of their business. Banks are usually using: a) systems which track the progress of transactions, based on which banks estimate the pipeline risks 1 ; b) gap analysis showing the assets and liabilities at the different repricing dates, and the sensitivity of the present value of these buckets to different scenarios in interest rates; and c) simulation techniques using scenarios that calculate the impact of changes in market conditions, e.g. the different repricing instruments, simulation of interest rate paths, customer behaviours etc. 11. Furthermore, stress testing can also be performed, in order to measure banks vulnerability under stresses market conditions like abrupt changes in the 1 A pipeline risk would occur for instance when a tranche of fixed-rate mortgages still to be sold where the corresponding interest swap has already been executed.
5 5 level and scope of the term structure of interest rates, changes in the relationships among key market rates 2, etc. 12. When using gap analysis and/or simulation techniques, banks measure the IRRBB under different shifts of the term structure of interest rate (parallel shifts and yield curve twists). 13. Based on those various tools, banks use different types of hedges to mitigate the risks, or use limits usually on earnings and/or economic value. Some banks set aside capital buffers. 14. The management body sets out the IRRBB policy. Although the specific organization established to put into effect the IRRBB policy may vary, in large or more complex banks, measuring, monitoring and controlling IRRBB is usually vested in a Asset and Liability Management (ALM) function. It is usually assigned to an independent risk control unit. Some banks also have a committee with powers delegated by the board, usually called Asset and Liability Committee (ALCO), responsible for major interest rate risk hedging and new asset and liability decisions. 15. There are various levels of centralization of ALM within banks, e.g. in cross border groups some may have a centralized management and assessment functions for IRRBB while others do not. III. Variables monitored in the IRRBB process 16. Banks usually consider two different, but complementary, perspectives in their process of assessing IRRBB. 17. The earnings perspective focuses on the sensitivity of earnings in the shortterm to interest rate movements. Banks usually adopt this perspective due to two main reasons: - this is the variable through which an interest rate change has an immediate impact on reported earnings; - the assessment of interest rate risk from an economic value perspective is difficult because it is mainly based on assumptions about the behaviour of long-term instruments, such as stable demand deposits on other noninterest bearing balance sheet items and those with embedded options. 18. The economic value perspective focuses on the sensitivity of the economic values of changes. Some banks may use this approach as the shorter term earnings perspective will not completely capture the impact of interest rate movements on the market value of long term positions Supervisory considerations 19. A number of considerations arise from the above Risk assessment should be done within the scope of SRP process, be it at a consolidated, sub-consolidated or solo level. When it comes to cross-border groups, the cooperation between home and host 2 Further guidance on this issue is provided in the BNB s document Guidance on stress testing.
6 6 supervisors will take into consideration the level and the manner in which the IRB management is performed by the institutions; As it has not been standard practice to require additional own funds (regulatory capital) for interest rate risk in the banking book, the BNB will need to develop own approaches to the use of this prudential measure, where considered necessary; BNB encourages development and application of advanced models and techniques; The level playing field is guaranteed by the BNB in terms of maintaining a consistent and fair approach to IRRBB; The administrative burden should not be excessive; The supervisory policy on interest rate risk and any information obtained under that policy should be complementary to aggregate financial stability analyses across banks; Considerations should be given to the absolute or relative size of the non-trading activities, in a way comparable to the Pillar 1 market risk regulation for interest rate risk in the trading book, with a view to implement these guidelines un a proportionate manner. 20. The concept of proportionality, as laid down in the Law on credit institutions (Article 79, paragraph 3) related to Pillar 2, applies also to IRRBB measurement and management, the complexity of which will be expected to be related to the size of the banks as well as to the sophistication and diversification of their activities. 21. There are arguments both for and against standardized reporting of interest rate risk in the banking book, as well as for and against the possible middle ground of standardized reporting applied to less complex banks and nonstandardized reporting applied to complex banks. This paper expresses no preferences in this respect. 22. Nonetheless, and in the context of Article 11, paragraphs 2-3 of Regulation No. 8, and according to Article 103, paragraph 1, item 11 of LCI, banks should at least be able to compute and report the effects of the standard shock described in IRRBB 2 and 5 on economic value as well as the amount of internal capital set aside, where considered necessary, for interest rate risk in the banking book. As noted in paragraph 6 and subject to proportionality considerations, banks are also expected to consider interest rate risk against earnings and should therefore consider the effect of instantaneous or gradual interest rate changes on shortterm earnings. The result of such analysis may be requested as additional information by the BNB. 23. Whichever approach to reporting is employed, the BNB should collect sufficient information about internal methodologies and underlying assumptions (e.g. yield curves used, internal measurement of positions without contractual maturity, treatment of optionality,etc.) for them to evaluate the reported information and to make their own assessment of the adequacy of the results of interest rate risk measurement. 24. Off site supervision can take place on the basis of bank s internal reports and/or following some standardized, supervisory format. BNB can also undertake on-site inspections.
7 7 Chapter two Guidance for banks related with interest rate risk in the banking book (IRRBB 1): Banks should be able to demonstrate that their internal capital is commensurate with the level of the interest rate risk in their banking book. In that respect, banks should be able to calculate: Potential changes in their value resulting from changes in the levels of interest rates. It is the responsibility of the banks to develop and use their own methodologies in accordance with their risk profile and risk management policies. BNB may reserve the right to require banks to apply an additional standardized methodology, when for example the bank s internal methodology is inadequate or does not exist. An example of such a methodology is provided by the standardized framework of Annex 4 of the supporting Basel document Principles for the management and supervision of interest rate risk (see annex 2); The overall interest rate risk in the banking book at various levels of consolidation, sub-consolidation and solo entity if required to do so by the BNB. (IRRBB 2): Banks must be able to compute and report to the BNB the change in their economic value as a result of applying a standard shock prescribed by the BNB (see IRRBB 5 below). If as a result of this standard shock a bank s economic value were to decline by more than 20 % of own funds it should be prepared to discuss with the BNB measures which might need to be taken to mitigate such a potential decline. (IRRBB 3): Besides the standard shock, banks should be able to measure their exposure, if material, and sensitivity to changes in the shape of the yield curve, changes between different market rates (i.e. basis risk) and changes to assumptions, for example those about customer behaviour. Banks should also consider whether a purely static analysis of the impact on their current portfolio of a given shock or shocks should be supplemented by a more dynamic approach. Larger and/or more complex banks should also take into account scenarios where different interest rate paths are computed and where some of the assumptions (e.g. about behaviour, contribution to risk and balance sheet size and composition) are themselves functions of interest rate levels. (IRRBB 4): Banks should have a well reasoned, robust and documented policy to address all issues that are important to their individual circumstances. Without prejudice to the principle of proportionality, examples of such issues include: The internal definition and boundary between banking book / trading activities ;
8 8 The definition of economic value and its consistency with the method used to value assets and liabilities (for example based on the discounted value of future cash flows, on the discounted value of future earnings); The size and the form of the different shocks to be used for internal calculations; The use of a dynamic and / or static approach in the application of interest rate shocks; The treatment of commonly called pipeline transactions (including any related hedging); The aggregation of multicurrency interest rate exposures; The treatment of basic risk resulting from different interest rate indexes; The inclusion (or not) of non-interest bearing assets and liabilities of the banking book (including capital and reserves); The treatment of current and savings accounts (i.e. the maturity attached to exposures without a contractual maturity); The appropriate consideration of embedded options in assets or liabilities; The extent to which sensitivities to small shocks can be scaled up linearly without material loss of accuracy (i.e. covering both convexity generally and the non-linearly of pay-off associated with explicit option products); The degree of granularity employed (e.g. offsets within a time bucket); Whether all future cash flows or only principal balances are included. Chapter 3 Activities of the BNB related to the interest rate risk in the banking book (IRRBB 5): BNB should set a comparable standard shock applicable to the non-trading book of all banks. BNB may decide to set different standard shocks for different currencies. The following guidelines will be in place: A standard shock could, for example be set so that it will be broadly equivalent to the 99-th percentile of observed interest rate changes (five years of observed one day movements scaled up to a 240 day year). This would currently equate approximately to a parallel 200 basis points shock for major currencies as suggested by the Basel Committee (see Annex 2 below); BNB uses this as its starting point when considering at what level to set the shock, but also should take into account factors such as the general level of interest rates, the shape of the yield curve and any relevant national characteristics in the financial system; BNB periodically review the size of the shocks in the light of changing circumstances, in particular the general level of interest rates (for instance periods of very low interest rates) and flexible enough to compute their sensitivity to any standardized shock that is prescribed by the BNB.
9 9 Frequent or minor amendments for the purpose of spurious statistical accuracy should not be made; BNB periodically discusses the relevance of the 200 basis points as a starting point when considering at what level to set the shock and keeps it under review in light of implementation; If the required shock (e.g. a 200 basis point shock) would imply negative interest rates or if such a shock would otherwise be considered inappropriate, the BNB will adjust the requirements accordingly; Where a bank is a subsidiary of an institution which is authorized in another EU member state, the BNB and respective supervisors will in accordance with the CEBS guidelines on supervisory cooperation for crossborder banking and investment firm groups, seek to coordinate their approaches on the standard shocks to be applied. (IRRBB 6): The supervisory review should encompass both the qualitative and organizational aspects of interest rate risk management, an evaluation of the bank s quantification of interest rate risk and an assessment of the adequacy of the relationship between interest rate risk and internal capital. This approach will be tailored to a bank s specific risk profile, drawing on the Basel Supporting Document Principles for the management and supervision of interest rate risk - see annex 1 below. (IRRBB 7): The scope of application of the supervisors assessment of interest rate risk is that used for the Supervisory Review Process (SRP). Where necessary for the fulfillment of their statutory objectives, for instance where there are obstacles to cash movements among subsidiaries or separate management processes among subsidiaries, the BNB will have the discretion to apply assessments at the level of individual entities. (IRRBB 8): BNB should understand the bank s internal method for calculating the IRRBB, including underlying assumptions (e.g. yield curves used, treatment of optionality). This will include allowing for BNB to have an in-depth analysis and assessments of bank internal methods (including banks assumptions underlying the issues raised in IRRBB 4 above). This could form the basis for peer group analysis and/or (model) benchmarking, and offer the supervisor a handle for discussions with the bank. Banks may be requested to calculate the effects of specific interest rate scenarios. (IRRBB 9): Prompt prudential measures of the BNB, including both qualitative and quantitative elements tailored to an institution s specific circumstances, may be required from either the overall supervisory assessment in response to a bank reporting that its economic value may decline by more than 20% of own funds as a result of applying the supervisory standard shock.
10 10 BNB should take into account not only the decline on the economic value but also the current level of the economic value. The range of possible supervisory measures could be but are not limited to: Improvement of risk management arrangements; Variations to internal limits; Reduction of the risk profile; Increase in the amount of required regulatory capital. The measure(s) used in response to the application of the standard shock will depend, inter alia, on the complexity of the calculation method used and the appropriateness of the standard hock and the level of the economic value. If the reduction in economic value is determined by a relatively straightforward or standard method of calculation, the reaction of the BNB might be to request additional, possibly internal, information. If the reduction is based on the outcome of a more complex model about which the BNB have greater information, they might reach an assessment of the appropriate measure(s) more quickly. In the latter case, the choice of the measure can take into account elements such as: The absolute and relative size of the exposure; The effects of other shifts or twists in the yield curve (other than the standardized); The treatment of multi-currency aggregation; The treatment of optionality and behavioural maturity, for example of current and savings accounts; The expected impact on earnings and the timing thereof; The quality of risk management, the internal systems and methodologies and the internal control system; The market segments in which the bank is active; The link with other risk exposures of the bank, for example credit risk; Peer group comparison (and benchmarking where the methodologies are similar); The composition of the bank s own funds; and The relationship between the quantity of the bank s internal capital and regulatory own funds and the quantity of its actual surplus of regulatory own funds.
11 11 Appendix I Basel Supporting Document on Interest Rate Risk The 15 principles given in the Basel Supporting Document Principles for the Management and Supervision of Interest Rate Risk, July 2004, are listed below: Board and senior management oversight of interest rate risk Principle 1: In order to carry out its responsibilities, the board of directors in a bank should approve strategies and policies with respect to interest rate risk management and ensure that senior management takes the steps necessary to monitor and control these risks consistent with the approved strategies and policies. The board of directors should be informed regularly of the interest rate risk exposure of the bank in order to assess the monitoring and controlling of such risk against the board s guidance on the levels of risk that are acceptable to the bank. Principle 2: Senior management must ensure that the structure of the bank s business and the level of interest rate risk it assumes are effectively managed, that appropriate policies and procedures are established to control and limit these risks, and that resources are available for evaluating and controlling interest rate risk. Principle 3: Banks should clearly define the individuals and/or committees responsible for managing interest rate risk and should ensure that there is adequate separation of duties in key elements of the risk management process to avoid potential conflicts of interest. Banks should have risk management, independent from position-taking functions of the bank and which report risk exposures directly to senior management and the board of directors. Larger or more complex banks should have a designated independent unit responsible for the design and administration of the bank s interest rate risk measurement, monitoring and control functions. Adequate risk management policies and procedures Principle 4: It is essential that banks interest rate risk policies and procedures are clearly defined and consistent with the nature and complexity of their activities. These policies should be applied on a consolidated basis and, as appropriate, at the level of individual affiliates, especially when recognizing legal distinctions and possible obstacles to cash movements among affiliates. Principle 5: It is important that banks identify the risks inherent in new products and activities and ensure these are subject to adequate procedures and controls before being introduced or undertaken. Major hedging or risk management initiatives should be approved in advance by the board or its appropriate delegated committee.
12 12 Risk measurement, monitoring and control functions Principle 6: It is essential that banks have interest rate risk measurement systems that capture all material sources of interest rate risk and that assess the effect of interest rate changes in ways that are consistent with the scope of their activities. The assumptions underlying the system should be clearly understood by risk managers and bank management. Principle 7: Banks must establish and enforce operating limits and other practices that maintain exposures within levels consistent with their internal policies. Principle 8: Banks should measure their vulnerability to loss under stressful market conditions including the breakdown of key assumptions - and consider those results when establishing and reviewing their policies and limits for interest rate risk. Principle 9: Banks must have adequate information systems for measuring, monitoring, controlling and reporting interest rate exposures. Reports must be provided on a timely basis to the bank s board of directors, senior management and were appropriate, individual business line managers. Internal controls Principle 10: Banks must have an adequate system of internal controls over their interest rate risk management process. A fundamental component of the internal control system involves regular independent reviews and evaluations of the effectiveness of the system and, where necessary, ensuring that appropriate revisions or enhancements to internal controls are made. The results of such reviews should be available to the relevant supervisory authorities. Information for the supervisory authorities Principle 11: Supervisory authorities should obtain from banks sufficient and timely information with which to evaluate their level of interest rate risk. This information should take appropriate account of the range of maturities and currencies in each bank s portfolio, including off-balance sheet items, as well as other relevant factors, such as the distinction between trading and non-trading activities. Capital adequacy Principle 12: Banks must hold capital commensurate with the level of interest rate risk they undertake. Disclosure of interest rate risk Principle 13: Banks should release to the public information on the level of interest rate risk and their policies for its management.
13 13 Supervisory treatment of interest rate risk in the banking book Principle 14: Supervisory authorities must assess whether the internal measurement system of banks adequately capture the interest rate risk in their banking book. If a bank s internal measurement system does not adequately capture the interest rate risk, banks must bring the system to the required standard. To facilitate supervisors monitoring of interest rate risk exposures across institutions, banks must provide the results of their internal measurement systems, expressed in terms of the threat to economic value, using a standardized interest rate shock. Principle 15: If supervisors determine that a bank is not holding capital commensurate with the level of interest rate risk in the banking book, they should consider remedial action, requiring the bank either to reduce its risk, to hold a specific additional amount of capital, or a combination of both.
14 14 Appendix II Basel Committee on Banking Supervision Principles for the management and supervision of interest rate risk July 2004 Annex 4 An example of a standardized framework 1. This annex contains an example setting out methodology and calculation process in one version of a standardized framework. Other methodologies and calculation processes could be equally applicable in this context, depending on the circumstances of the bank concerned. Such a framework is intended for supervisory reporting purposes only, and is not intended to represent an adequate framework for internal risk management purposes. A. Methodology 2. Positions on the bank s balance sheet would be slotted into maturity approach according to the following principles: a) All assets and liabilities belonging to the banking book and all off-balance sheet items belonging to the banking book which are sensitive to changes in interest rates (including all interest rate derivatives) are slotted into a maturity ladder comprising a number of time bands large enough to capture the nature of interest rate risk in a national banking market. Annex 2 discusses issues relating to the selection of appropriate time bands. Separate maturity ladders are to be used for each currency accounting for more than 5% of either banking book assets or liabilities; b) On-balance sheet items are treated at book value; c) Fixed-rate instruments are allocated according to the residual term to maturity and floating-rate instruments according to the residual term to the next repricing date; d) Exposures which create practical processing problems because of their large number and relatively small amount (e.g. installment or mortgage loans) may be allocated on the basis of statistically supported assessment method; e) Core deposits are slotted according to an assumed maturity of no longer then five years; f) National supervisors will provide guidance on how other items with a bahavioural maturity or repricing that differ from contractual maturity or repricing are to be slotted into the time band structure; g) Derivatives are converted into positions in the relevant underlying. The amounts considered are the principal amounts of the underlying or of the notional underlying; h) Futures and forward contracts, including forward rate agreements (FRA), are treated as a combination of a long and a short position. The maturity of a future or a FRA will be the period until delivery or exercise of the
15 15 contract, plus where applicable - the life of the underlying instrument. For example, a long position in a June three month interest rate future (taken in April) is to be reported as a long position with a maturity of five months and a short position with a maturity of two months; i) Swaps are treated as two notional positions with relevant maturities. For example, an interest rate swap under which a bank is receiving floatingrate interest and paying fixed rate interest will be treated as a long floating-rate position of maturity equivalent to the period until the next interest fixing and a short fixed-rate position of maturity equivalent to the residual life of the swap. The separate legs of cross currency swaps are to be treated in the relevant maturity ladders for the currencies concerned; j) Options are considered according to the delta equivalent amount of the underlying or of the notional underlying. B. Calculation process 3. The calculation process consists of two steps: a) The first step is to offset the longs and shorts in each time band, resulting in a single short or long position in each time band; b) The second step is to weight these resulting short and long positions by a factor that is designed to reflect the sensitivity of the positions in the different time bands to an assumed change in interest rates. The set of weighting factors for each time band is set out in Table 1 below. These factors are based on an assumed parallel shift of 200 basis points throughout the time spectrum, and on a proxy of modified duration of positions situated at the middle of each time band and yielding 5%; c) The third step is to sum these resulting weighted positions, offsetting longs and shorts, leading to the net short or long-weighted position of the banking book in a given currency; d) The fourth step is to calculate the weighted position in the whole banking book by summing the net short- and long-weighted positions calculated for different currencies; e) The fifth step is to relate the weighted position of the whole banking book to capital. Table 1 is provided in the Basel document itself. Bank Supervision Department
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