The financial district in Frankfurt, Germany, on March 18, 2019.RALPH ORLOWSKI/Reuters
Banks in the European Union face closer scrutiny of how they assess the impact of interest rate changes on their balance sheets after an initial examination uncovered a patchwork of approaches, the bloc’s banking watchdog said on Wednesday.
The European Banking Authority (EBA) last year discussed with banks how they apply a rule known as interest rate risk in the banking book or IRRBB written by the global Basel Committee.
Basel has begun considering tweaks to the IRRBB, such as requiring banks to take into account bigger potential rate shocks in their calculations, and EBA’s findings will feed into this work.
Under IRRBB, banks have to assess the impact of different interest rate ‘shocks’ in each currency they are materially exposed to.
“Due to the variety of models implemented by institutions, additional support might be required for both regulators and supervisors to better understand how the IRRBB risks are assessed and covered,” EBA said in a report on Wednesday.
The aim is to check if banks are making justified assumptions and judgements in their modelling, especially after sharp rises in central bank rates over the past two years, and what hedging strategies they use.
“The transmission of these higher interest rates to the real economy may not have yet fully materialised,” John Schindler, secretary general of the G20′s Financial Stability Board, which includes the Basel Committee as a member, said this week.
“Therefore there is still the risk of rising debt service and other challenges to come.”
After the initial stock-take last year, EBA will now undertake deep dives this year and next into specific elements of IRRBB, in particular how rate risks affect so-called net interest income of banks.
This refers to the difference between the money banks earn from interest-bearing assets such as loans and mortgages, and expenses from paying interest on savings accounts.
It is the latest sign of how regulators are checking the impact of the end to cheap money on different parts of the financial system.