APS 117 Capital Adequacy: Interest Rate Risk in the Banking Book

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About this standard

This standard supports
APS 110
Capital Adequacy, which is a core standard in the Financial Resilience Pillar. Some or all parts apply to most ADIs. It does not apply to purchased payment facility providers. APRA may determine this standard applies to a foreign ADI.

Objective and key requirements of this Prudential Standard This Prudential Standard sets out the requirements that an authorised deposit-taking institution must meet to ensure it prudently manages interest rate risk in the banking book. The key requirements of this Prudential Standard are that an authorised deposit-taking institution must:
have a framework to manage, measure and monitor interest rate risk in the banking book, commensurate with the nature, scale and complexity of its operations; and be approved by APRA to use an internal model for determining its interest rate risk in the banking book capital charge.

Preamble

Prudential Standard APS 117
Capital Adequacy: Interest Rate Risk in the Banking Book Authority This Prudential Standard is made under section 11AF of the Banking Act 1959 (Banking Act).
Application
This Prudential Standard applies to all authorised deposit-taking institutions ( ADIs ), other than foreign ADIs and purchased payment facility providers . Additionally, APRA may determine that this Prudential Standard applies to a specified foreign ADI if APRA considers that the foreign ADI is not appropriately managing, measuring or monitoring its IRRBB or is carrying excessive interest rate risk, and require the foreign ADI to comply with some or all of the requirements in this Prudential Standard. A reference to an ADI in this Prudential Standard, unless otherwise indicated, is a reference to:
an ADI on a
Level 1 basis; and a group of which an ADI is a member on a Level 2 basis.
If an ADI to which this Prudential Standard applies is:
the holding company for a group, the ADI must ensure that the requirements in this Prudential Standard are met on a Level 2 basis, where applicable; or a subsidiary of an authorised non-operating holding company ( authorised NOHC) , the authorised NOHC must ensure that the requirements in this Prudential Standard are met on a Level 2 basis, where applicable. A non-significant financial institution ( non-SFI ) does not have to comply with the requirements in paragraphs 17 to 63, and Attachment A to this Prudential Standard , unless otherwise required by APRA under paragraph 16 of this Prudential Standard . An ADI that has IRRBB model approval must satisfy all of the requirements set out in this Prudential Standard. Significant Financial Institutions ( SFIs ) that do not have IRRBB model approval must satisfy all of the requirements in this Prudential Standard with the exception of paragraphs 47(b), 57, 60, 62, 63, and Attachment A, unless otherwise required by APRA under paragraph 16 of this Prudential Standard , in a way that is commensurate with the nature, scale and complexity of the ADI’s operations. This Prudential Standard commences on 1 January 2027. Interpretation Terms that are defined in Prudential Standard CPS 001 Defined terms appear in bold the first time they are used in this Prudential Standard . Where this Prudential Standard provides for APRA to exercise a power or discretion, this power or discretion is to be exercised in writing. In this Prudential Standard, unless the contrary intention appears, a reference to an Act, Regulations or Prudential Standard is a reference to the Act, Regulations or Prudential Standard as in force from time to time. Definitions The following definitions are used in this Prudential Standard:
approved IRRBB model – means a currently APRA-approved internal model for determining an ADI’s IRRBB capital charge; banking book – an ADI’s banking book is comprised of:
on-balance sheet asset, liability or equity items that are:
not part of an ADI’s trading book, as determined under the ADI’s trading book policy statement (refer to Attachment A to Prudential Standard APS 116 Capital Adequacy: Market Risk ( APS 116 )); not deducted from an ADI’s Common Equity Tier 1 Capital under Prudential Standard APS 111 Capital Adequacy: Measurement of Capital ( APS 111 ); and not included in an ADI’s Common Equity Tier 1 Capital (refer to APS 111 ); or an off-balance sheet position that alters an ADI’s exposure to interest rate risk and is not part of the ADI’s trading book. calculation date – means the date with reference to which an ADI’s IRRBB capital charge is calculated, such that the exposures and observations of interest rates used in the calculation are recorded at the close of business on that day; earnings at risk – means the potential impact of interest rate changes on the net interest income earned on the ADI’s banking book; economic value – means:
fair value, where it can be determined; or the net present value of expected cash flows, otherwise; economic value sensitivity – means the potential impact of interest rate changes on the economic value of the ADI’s banking book; IRB ADI – means an ADI that has been granted approval by APRA to use the internal ratings-based (IRB) approach to credit risk ; IRRBB capital charge – means the capital that an ADI is required to hold in relation to IRRBB; IRRBB management framework – means the organisational structures, processes and systems used in identifying, assessing, measuring, monitoring, controlling and mitigating IRRBB; IRRBB measurement system – means the systems and data used to measure IRRBB. An ADI’s IRRBB measurement system forms part of its IRRBB management framework. For an ADI that has IRRBB model approval, the IRRBB measurement system includes, but is not limited to, its approved IRRBB model; IRRBB model approval – means an approval granted by APRA, for an ADI to use an internal model for determining its IRRBB capital charge; optionality risk – means the risk of loss in earnings or value due to cash flows varying from what an ADI had assumed, caused either by customers exercising stand-alone or embedded options differently from how the ADI had assumed they would, or by the operation of caps, floors and similar mechanisms that automatically adjust interest payments; rate lock – means a guarantee by an ADI that a customer may draw down a loan no larger than a nominated limit, at a specified fixed or capped rate, before a nominated expiry date; and standardised ADI – means an ADI which has not been approved by APRA to use the IRB approach to credit risk. Adjustments and exclusions APRA may adjust or exclude a specific prudential requirement in this Prudential Standard in relation to one or more specified ADIs or authorised NOHCs. Previous exercise of discretion An ADI must contact APRA if it seeks to place reliance, for the purposes of complying with this Prudential Standard, on a previous exemption or other exercise of discretion by APRA under a previous version of this Prudential Standard.

Requirements for all ADIs

IRRBB is a material risk and is a category of market and investment risk under Prudential Standard CPS 220 Risk Management ( CPS 220 ). As part of its risk management framework required under CPS 220 , an ADI must ensure that it appropriately manages its IRRBB, commensurate with the nature, scale and complexity of its operations.

An ADI’s senior management must regularly (at least semi-annually) report its IRRBB exposure to its Board or Board committee.

Where APRA determines that an ADI is not appropriately managing, measuring or monitoring its IRRBB or is carrying excessive interest rate risk, APRA may require the ADI to hold additional regulatory capital, commensurate with its IRRBB and/or, in the case of a non-SFI or an SFI that does not have IRRBB model approval , comply with all or additional requirements in this Prudential Standard. IRRBB model approval IRRBB model approval – means an approval granted by APRA, for an ADI to use an internal model for determining its IRRBB capital charge;

Requirements for SFIs

An SFI must prudently manage IRRBB with a management framework and governance arrangements that satisfy the requirements set out in the remainder of this Prudential Standard.

An SFI that has sought approval from APRA to become an IRB ADI must also apply for IRRBB model approval.
IRB ADI
IRB ADI – means an ADI that has been granted approval by APRA to use the internal ratings-based (IRB) approach to credit risk ;

An IRB ADI must hold adequate capital for its IRRBB and must determine its IRRBB capital charge at least quarterly.
IRRBB capital charge
IRRBB capital charge – means the capital that an ADI is required to hold in relation to IRRBB;

For a standardised ADI
, the IRRBB capital charge is zero unless APRA determines otherwise. standardised ADI standardised ADI – means an ADI which has not been approved by APRA to use the IRB approach to credit risk.

Internal model approval process

An application for IRRBB model approval must demonstrate that the model has undergone a sufficiently long period of internal monitoring and has performed satisfactorily over that period. The length of this monitoring period will depend upon the performance of the ADI’s IRRBB management framework and its track record in managing and measuring IRRBB. APRA may approve the use of an IRRBB model by an ADI. IRRBB management framework IRRBB management framework – means the organisational structures, processes and systems used in identifying, assessing, measuring, monitoring, controlling and mitigating IRRBB;

An ADI must obtain APRA’s approval prior to making any material changes to its approved IRRBB model . An ADI must notify APRA of any non-material changes no later than three months after making the change. approved IRRBB model approved IRRBB model – means a currently APRA-approved internal model for determining an ADI’s IRRBB capital charge;

An ADI that has IRRBB model approval must continue to use its approved IRRBB model to determine its IRRBB capital charge unless APRA revokes the approval.

An ADI that has IRRBB model approval must determine its IRRBB capital charge in accordance with Attachment A to this Prudential Standard . The ADI may rely on its own internal methods and estimates for those parts of the calculation where a method or estimate is not prescribed in Attachment A to this Prudential Standard .

APRA may, at any time, vary or revoke an ADI’s IRRBB model approval, or impose additional conditions on the approval if it determines that:

the ADI does not comply with this Prudential Standard; or

it is appropriate, having regard to the particular circumstances of the ADI.

For an IRB ADI that does not have IRRBB model approval, the ADI must determine its IRRBB capital charge using a method specified by APRA.

APRA may require an ADI to reduce its level of IRRBB or increase its IRRBB capital charge.

Partial use of internal model

An IRRBB model approval may permit partial use, which allows an ADI to use a combination of the approved IRRBB model and an alternative approach approved by APRA for the purposes of calculating its IRRBB capital charge.

As part of an application for IRRBB model approval, an ADI must provide APRA with appropriate written information on the proposed scope of its approved IRRBB model. An ADI must not change the scope of its approved IRRBB model unless it has obtained APRA’s prior approval for the change.

An ADI with approval for partial use must notify APRA prior to commencing any new business activity that generates IRRBB and which the ADI did not include in the application for IRRBB model approval.

Approval for partial use will, at a minimum, require that:

the ADI’s IRRBB capital charge captures all material sources of IRRBB; and

the calculation of the IRRBB capital charge does not recognise diversification benefits for any part of the ADI’s operations that the approved IRRBB model excludes.

APRA may approve partial use on a short-term basis. An ADI that has received such approval must have a written, APRA-approved implementation plan that specifies the extent and timing of the extension of the approved IRRBB model to cover all material business activities.

APRA will approve permanent partial use only in exceptional circumstances and where an ADI is able to demonstrate to APRA’s satisfaction that the business activities not covered by the approved IRRBB model are immaterial in aggregate in terms of size and perceived risk profile. APRA may specify an amount to be added to the IRRBB capital charge in respect of business activities that are not covered.

IRRBB management framework

As part of its risk management framework required under CPS 220 , an ADI must develop and maintain:

an assessment of the ADI’s IRRBB profile with a defined risk appetite statement articulated in terms of the risk to both economic value and earnings and must specify limits on both those risks [1] ; economic value economic value – means:
fair value, where it can be determined; or the net present value of expected cash flows, otherwise; [1] The IRRBB profile includes the profile of spread risk.

clearly articulated responsibilities of, and reporting relationships to, the Board and where applicable, the Board committee; and

accountabilities for monitoring an ADI’s exposures against limits, approving variation on limits, and responding to and escalating any breaches of IRRBB limits to the Board and/or senior management as appropriate.

An ADI must notify APRA prior to making any material change to its IRRBB management framework.

Responsibilities of the Board of directors

An ADI’s Board, or Board committee, must regularly (at least semi-annually) review IRRBB management reports (refer to paragraphs 50 to 53 of this Prudential Standard ) and satisfy itself that IRRBB is appropriately managed.

Responsibilities of senior management

Senior management responsible for the implementation of the ADI’s IRRBB management framework must be actively involved and ensure its effective operation.

Where an ADI assumes a maturity profile for shareholders’ equity, its senior management must set and approve a strategy consistent with the IRRBB risk appetite set by the Board, including the scope of any delegated powers to materially vary from that maturity profile.

Significant hedging, risk-taking or risk management initiatives in relation to IRRBB must be approved by senior management prior to implementation. Senior management must ensure that they receive and monitor reports on the actual variation of exposures.

Senior management in conjunction with the IRRBB risk management function referred to in paragraph 43 of this Prudential Standard , must develop and implement appropriate policies relating to the IRRBB management framework.

Senior management must ensure that reporting to the Board or Board Committee enables the Board or Board committee to satisfy itself that IRRBB is appropriately managed. The reporting will at a minimum, include:

balance sheet management strategy (including maturity profile for shareholders’ equity) with appropriate risk metrics that measure this strategy;

material changes to the ADI’s banking book profile or exceptions from established policies that could have an impact on the operation of the risk management framework for IRRBB, including the IRRBB capital charge; and banking book banking book – an ADI’s banking book is comprised of:
on-balance sheet asset, liability or equity items that are:
not part of an ADI’s trading book, as determined under the ADI’s trading book policy statement (refer to Attachment A to Prudential Standard APS 116 Capital Adequacy: Market Risk ( APS 116 )); not deducted from an ADI’s Common Equity Tier 1 Capital under Prudential Standard APS 111 Capital Adequacy: Measurement of Capital ( APS 111 ); and not included in an ADI’s Common Equity Tier 1 Capital (refer to APS 111 ); or an off-balance sheet position that alters an ADI’s exposure to interest rate risk and is not part of the ADI’s trading book.

significant assumptions of the measurement system and how those assumptions affect any significant IRRBB hedging strategies the ADI undertakes.

An ADI must have in place an executive committee, with appropriate representation from across the ADI, which focuses on the management and measurement of IRRBB. The executive committee must hold regular meetings to discuss matters including the performance of the framework, areas requiring improvement and the status of efforts to address previously identified deficiencies.

IRRBB risk management

In meeting its risk management requirements under CPS 220 for IRRBB, an ADI must:

have reporting lines and responsibilities that are independent of the activities that contribute to the ADI’s IRRBB profile and must provide access for the risk management function to the executive committee referred to in paragraph 42 of this Prudential Standard ;

ensure that roles and responsibilities of personnel and functions involved in the management of IRRBB are clearly defined and documented;

have responsibility for the design and maintenance of an ADI’s risk management framework for IRRBB;

continuously monitor the ADI’s compliance with the risk management framework for IRRBB, and produce and analyse regular reports on the output of the IRRBB measurement system , including any approved IRRBB model; and IRRBB measurement system IRRBB measurement system – means the systems and data used to measure IRRBB. An ADI’s IRRBB measurement system forms part of its IRRBB management framework. For an ADI that has IRRBB model approval, the IRRBB measurement system includes, but is not limited to, its approved IRRBB model;

provide challenge of the balance sheet management strategy (including the maturity profile for shareholders’ equity and balance sheet risk-taking).

New products

Prior to introducing a new product, instrument type or activity, an ADI must assess and understand the IRRBB characteristics and have adequate operational procedures and risk control systems in place.

IRRBB measurement system

In relation to an ADI’s IRRBB measurement system, the system must:

be conceptually sound, comprehensive, consistently implemented and transparent;

be sufficiently comprehensive to capture all material sources of IRRBB across the ADI including, for an ADI with model approval, those events that can lead to rare and severe losses; and

capture reliable and accurate data about exposures in a timely fashion, and the effectiveness and accuracy of this process must be periodically tested.

In relation to an ADI’s IRRBB measurement system, the ADI must:

regularly monitor its IRRBB profile in terms of both earnings at risk and economic value sensitivity ; [2] earnings at risk earnings at risk – means the potential impact of interest rate changes on the net interest income earned on the ADI’s banking book; economic value sensitivity economic value sensitivity – means the potential impact of interest rate changes on the economic value of the ADI’s banking book; [2] The IRRBB profile includes the profile of spread risk.

periodically review the assumptions made in the system, and the materiality of any IRRBB not captured by the system; and

perform periodical sensitivity testing of key assumptions, including behavioural assumptions.

An ADI’s IRRBB measurement system must have comprehensive and detailed documentation, which must, at a minimum, include:

the specification of:

data sources and capture methods;

calculation method and assumptions, including behavioural and other assumptions about the timing of cash flows; and

the rationale for the calculation method and all assumptions;

and

for an ADI that has IRRBB model approval:

enough detail to make the approach to determining the ADI’s IRRBB capital charge transparent and capable of independent review, validation and independent reproduction of results given the raw input data;

details of any dependence structures used in the measurement system, including evidence supporting their use; and

where relevant, an explanation of how the ADI ensures that the required soundness standard in paragraph 38 of Attachment A to this Prudential Standard is achieved.

As part of its stress testing program under
CPS 220
, an ADI must consider the impact on the economic value of the banking book and net interest earnings of sudden changes in interest rates. This must at a minimum include:

scenarios that are tailored to the ADI’s businesses and risks;

scenarios involving changes in the level, slope and shape of yield curves, as well as changes in customer behaviour;

multiple stress scenarios, with some based on historical events and others being hypothetical and forward-looking; and

clearly defined objectives, well documented assumptions and sound methodologies.

An ADI’s policies and limits for IRRBB must reflect the results of stress testing exercises. Senior management must regularly communicate these results to the ADI’s Board or Board committee.

Internal reporting of IRRBB exposures

In developing an appropriate reporting framework, an ADI must consider the nature of its IRRBB exposure and the strategy adopted for managing and measuring it.

Management reports must be produced and reviewed regularly and must include information on limit utilisation, the performance of risk management strategies, and the output of the ADI’s risk measurement system, including its approved IRRBB model where applicable. The reviews must be conducted by management with authority to enforce, where necessary, mitigation of the ADI’s exposure to IRRBB.

An ADI must have in place a process for ensuring that the ADI’s Board, or Board committee, and senior management are able to respond appropriately to the information contained in IRRBB management reports. This process must include escalation procedures for key IRRBB issues to facilitate appropriate action between formal reporting cycles.

Senior management must notify the Board and APRA if its embedded gain is material in size relative to the remainder of its IRRBB capital charge, as set out in Attachment A to this Prudential Standard . This notification must include how the ADI is mitigating risks associated with this material embedded gain.

Integration of IRRBB measurement system into day-to-day risk management

An ADI’s IRRBB measurement system must be closely integrated into the ADI’s risk management processes. This requires that the inputs and outputs of the ADI’s IRRBB measurement system, as relevant, play an integral role in the ADI’s decision-making, corporate governance, risk management and internal capital allocation processes.

For an ADI that has IRRBB model approval, the ADI’s IRRBB economic value exposure limits must include limits that are related to the approved IRRBB model in a manner that is consistent over time and well understood by senior management.

Data

An ADI must have transparent and verifiable processes for collecting and testing relevant data inputs to its IRRBB measurement system (e.g. exposure information, details about customer behaviour and product and wholesale rate histories). These processes must be consistent, timely and comprehensive across the ADI.

An ADI's IRRBB exposure data must comprehensively capture all material exposures from relevant business activities, banking book items and geographic locations. An ADI must be able to demonstrate that any excluded exposures, both individually and in aggregate, would not have a material impact on the overall estimate of its IRRBB capital charge.

An ADI must document its IRRBB data management policies and procedures. These policies and procedures must, at a minimum, cover:

the collection of data;

processes for ensuring integrity, completeness, consistency and accuracy;

data storage;

application purposes; and

an outline of all data flows between systems, including whether any manual processes are involved in such flows.

Independent review of risk management framework for IRRBB

For the purposes of the review of the risk management framework in relation to IRRBB in CPS 220 , such reviews must be conducted by functionally independent, appropriately trained and competent personnel and must cover both the activities of relevant business units and the IRRBB management function.

For an ADI with an approved IRRBB model, such reviews must take place at the time of IRRBB model approval and thereafter at least once every three years and when a material change is made to the IRRBB management framework. A summary of the results of the review must be provided to the Board or Board committee. An ADI must provide a report on the review to APRA within three months of its completion.

For the purpose of the review, ‘functionally independent’ means that the party or parties conducting the reviews:

do not contribute to the ADI’s IRRBB profile through the origination or alteration of risk; and

must not be, or have been:

involved in the development, implementation or operation of the IRRBB measurement system; or

part of, or reporting to, the risk management function for IRRBB.

It is not necessary that the same party undertake all aspects of the review.
[3]
[3]
In most cases, the independent reviews could be facilitated by an ADI’s internal audit function, but it may require the engagement of independent parties outside of this function.

Regular model testing

An ADI that has IRRBB model approval must have a documented process in place to test the accuracy and consistency of its internal model and assumptions. The ADI must satisfy APRA that the process enables it to assess the performance of its internal model in a meaningful and consistent manner. An ADI must perform regular model testing against actual loss experience to ensure reasonableness of model estimates. An ADI must also document and regularly review the materiality of all model limitations and risks not captured by its internal model.

An ADI that has IRRBB model approval must have a robust and documented process for testing changes to its internal model, including assumptions and information that flows into that model.

Attachment A – Approved IRRBB models

This Attachment applies to an ADI that has an approved IRRBB model.

IRRBB capital charge

The IRRBB capital charge is calculated as:
where for a given repricing assumption , at a calculation date is the greater of zero and:
where:
are respectively the prospective IRRBB capital charges at the calculation date and the latest three month-ends, determined in accordance with paragraph 18 of this Attachment ; is the embedded loss at the calculation date. This is defined as the sum over all items within an ADI’s augmented banking book of the book value of minus the determined in accordance with paragraph 18 of this Attachment . For the avoidance of doubt, the ADI’s augmented banking book is determined in accordance with paragraph 29 of this Attachment and includes an earnings offset. As such, incorporates an earnings offset. A negative is permissible and represents an embedded gain. is the optionality capital charge at the calculation date, determined in accordance with paragraph 38 of this Attachment ; and is any other amount that APRA has notified the ADI it must include in the calculation of its IRRBB capital charge, or that has been calculated in accordance with a method specified by APRA. calculation date calculation date – means the date with reference to which an ADI’s IRRBB capital charge is calculated, such that the exposures and observations of interest rates used in the calculation are recorded at the close of business on that day;

Classification of banking book items

For the purpose of calculating its IRRBB capital charge, an ADI must classify banking book items in accordance with paragraphs 4 to 9 of this Attachment .

Market-related items

All securities
[4] in the banking book excluding debt, Transitional Additional Tier 1 Capital Instruments (as defined by APS 111 ) and Tier 2 Capital issued by the ADI are classified as market-related items. An ADI must designate each banking book item not covered by the previous sentence as either a market-related item or a non-market-related item. [5] The criterion for making such designations forms part of the approved IRRBB model, must be documented, and any change to it constitutes a model change that requires APRA approval. [4] In this context “securities” do not include derivatives. [5] All banking book derivatives are to be designated as market related items. However, if an ADI reasonably considers a banking book item is in an effective hedge relationship with a non-market-related item, it may designate a banking book item as a non-market-related item.

Where an ADI holds securities issued in a securitisation:

if the ADI is an originating ADI of the securitisation, as defined in Prudential Standard APS 120 Securitisation , and the ADI treats the securitisation’s underlying assets as on-balance sheet assets of the ADI under Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk or Prudential Standard APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk , the ADI must consolidate the balance sheet of the securitisation vehicle with the ADI’s balance sheet for the purpose of this Prudential Standard; or

the ADI must treat the securities as market-related, otherwise.

Non-market-related items

A non-market-related item is classified as principal-and-interest if it:

is a deposit; or

can be represented to an acceptable level of accuracy as a sequence of principal and interest cash flows. For this purpose, cash flows that are economically equivalent to interest, but are not described as such in the contract, must be treated as interest.

A derivative that is a non-market-related item should be decomposed, if possible, into notional long and short principal-and-interest items whose combined exposure is the same as that of the derivative. Non-market-related items that are not principal-and-interest are classified as non-principal-and-interest items for the purpose of this Prudential Standard.

A principal-and-interest item is classified as either:

a non-maturity deposit, which is a deposit that has no specified maturity date and can be withdrawn at any time without notice; or

an other principal-and-interest (OPI) item.

A core deposit is a component of a portfolio of non-maturity deposits that:

has a stable balance; and

pays an interest rate that:

is managed by the ADI; and

does not usually change in response to movements in wholesale market rates.

An ADI must determine the balance and repricing profile of each core deposit by a method whereby the balance is expected to usually be no more than 90 per cent of the balance of the deposit product, or portfolio of products or parts thereof, in which it lies.

An ADI may split a banking book item, or a portfolio of such items, into two or more parts, and classify or model each part differently. For the purpose of this Attachment, a reference to a banking book item may also refer to such a part and a reference to a portfolio of banking book items may refer to a portfolio of such parts. An ADI may, with APRA’s approval, treat multiple items arising from different products as a single item.

Interest rate data

For the purpose of this Prudential Standard, a risk factor is a stochastic process indexed by time, whose values are used in calculating economic values of banking book items, and for which negative values are possible. A reference to a risk factor at a specified date designates the random variable indexed by that date, in the process.

For each currency to which an ADI has a material exposure in the banking book, the ADI must identify and collect data to enable modelling of a single, maturity-indexed, collection of risk factors. This is the non-market-related curve or NMR curve for that currency. The risk factors in each NMR curve must correspond to interest rates suitable for discounting cash flows. An ADI may combine currencies to which it has non-material exposures into one or more groups and select a single NMR curve for each group based on rates in a currency, or composite of currencies, broadly reflective of the interest rate characteristics of the group. An ADI may, with APRA’s approval, use more than one NMR curve per currency to which an ADI has non-material exposures.

An ADI must also identify and collect data to enable modelling of all non-issuer-specific risk factors for which changes in their values can cause material changes in the economic value of the ADI’s market-related items. Where available, different risk factor collections (‘curves’) must be used for modelling the yields on different types and grades of debt issuers and different payment frequencies.

An ADI must use an observation period of eight years, which is to be constructed as the concatenation of:

Period A – fixed observation period (3.5 years), spanning 1 January 2020 to 30 June 2023; and

Period B – rolling observation period (4.5 years), incorporating the latest data excluding Period A, and ending on a date no earlier than three months before the calculation date.

The method used to choose the end date of the observation period for each calculation date must be specified. Observation dates are the business days in the observation period. Period B observation dates within the eight-year observation period are to be updated quarterly.

Calculation of the prospective IRRBB capital charge

The economic value of the banking book or augmented banking book (see paragraph 28 of this Attachment ) is the sum of the economic values of all items it contains.

The economic value (EV) of a banking book item, given a set of repricing assumptions and risk factor values, is:

for a non-market-related item, the net present value, as at the calculation date, of expected future notional cash flows (see paragraph 24 of this Attachment ), using discount rates from the relevant NMR curve; and

for a market-related item, the fair value of the item, based on the relevant risk factor values.

For a given repricing assumption , an ADI’s prospective IRRBB capital charge is the ADI’s estimate of the 97.5 per cent expected shortfall of the prospective loss [6] under repricing assumptions , where, for each possible rate scenario in the distribution of rate scenarios, the prospective loss is equal to:
is the EV of item under the central assumptions, using the values of risk factors at the calculation date; is the EV of item calculated using repricing assumptions , together with simulated risk factor values obtained by applying to risk factors at the calculation date, a shock determined for rate scenario in accordance with paragraph 19 of this Attachment ; is the augmented banking book (see paragraph 28 of this Attachment ); Note that is a random variable, whereas is not. [6] The 97.5 per cent expected shortfall is the expected loss conditional on the loss being in the worst 2.5 per cent of potential losses.

The distribution of each must be estimated using a simulation method under which:

the ADI designates every risk factor to be either perturbed or derived. This designation forms part of the approved IRRBB model, must be documented, and any change to it constitutes a model change;

there is one simulated scenario for each observation date;

for each perturbed risk factor and observation date, the simulated value of the risk factor to be used in the scenario for that observation date is:
where:
are the values of the risk factor at the calculation date, the observation date and ten business days before the observation date respectively; and

for each derived risk factor and observation date, the ADI must derive the simulated value of the risk factor at that date to be used in the scenario from the values simulated for other risk factors for the scenario.

For non-market-related items, only the risk factor values in the NMR curves that are used to discount notional cash flows may differ between the calculation of Pre-shock and Post-shock EVs for a given set of repricing assumptions (see paragraph 24 of this Attachment ). The notional cash flows in the Pre-shock and Post-shock EVs must be the same, other than for items with optionality, and for which APRA has approved a different treatment under paragraph 34 of this Attachment .

For market-related items, Post-shock EVs must be determined using either full revaluation or a sensitivity-based method approved by APRA. Risk factors whose values differ between the calculations of Pre-shock and Post-shock EVs are not limited to discount curves. Where a counterparty to an item, including an ADI customer, may exercise a choice in relation to the item, the ADI must assume the counterparty will exercise the choice in the way that is most adverse to the ADI.

Repricing Assumptions

An ADI’s repricing assumptions consist of:

the classification of banking book items into the categories described in paragraphs 4 to 9 of this Attachment ;

the allocations of types of OPI items to contractual or behavioural repricing profiles (see paragraph 33 of this Attachment ); and

the method of determining the cash flow profile (see paragraph 24 of this Attachment ) for non-market-related items, including the method for adjusting it in response to unexpected changes to the items, such as prepayments different from expectations.

In the calculations set out in paragraphs 16 to 21 of this Attachment , an ADI must use the following sets of repricing assumptions:

the central assumptions, which are the ADI’s own repricing assumptions, chosen in accordance with paragraphs 24 to 36 of this Attachment ;

the shorter assumptions, determined in accordance with paragraph 37 of this Attachment ; and

the longer assumptions, determined in accordance with paragraph 37 of this Attachment .

Central assumptions

An ADI must have a method of allocating a cash flow profile to each non-market-related item, consisting of a series of notional cash flows and associated dates at which they are assumed to occur.

The total value at a non-market-related item’s inception date of all its notional cash flows, each discounted using the NMR curve for its currency, must not be materially different to the consideration paid to establish the item, or the initial book value of the item if there is no such consideration.

The notional cash flows of a principal-and-interest item must be classified into notional principal cash flows and notional interest cash flows. The repricing profile of a principal-and-interest item is the set of notional principal cash flows and associated dates, which are called repricing dates. At any date, the future notional principal cash flows must sum to the principal then outstanding.

An ADI must have a documented method of determining the notional interest cash flows of a principal-and-interest item based on its notional principal cash flows, such that:

the notional interest cash flows occur on the dates upon which interest is actually required to be paid under the item, except that a notional interest cash flow associated with any notional principal cash flow occurring on the next business day after the calculation date may occur at the same time as the notional principal cash flow; and

projections of notional interest cash flows may be changed only to the extent that the change is necessitated by changes to the item’s repricing profile.

An ADI’s augmented banking book is the ADI’s banking book together with an earnings offset, which is a notional principal and interest item. The earnings offset must be calculated as the economic value, as at the beginning of the holding period, of a notional twelve-month, equally weighted, monthly moving average portfolio of fixed-for-floating interest rate swaps. The total principal amount covered by the swaps is equal to the sum of the book value of all banking book items.

For the earnings offset, the ADI must choose a repricing profile consisting of at least twelve outgoing notional principal cash flows, spaced evenly over the year following the calculation date, each of magnitude one-twelfth the book value of the banking book at the calculation date. Notional interest cash flows on the earnings offset must be determined in accordance with paragraphs 25 to 27 of this Attachment as if the earnings offset were incepted at the calculation date and a notional principal cash flow occurs, equal to all unpaid, accrued interest at that time.

For each type of core deposit, the repricing profile of the portfolio of all core deposits of that type must consist of a non-increasing series of notional principal cash flows spaced evenly over the period from the calculation date to the last in the series, which must be no more than five years after the calculation date.

For all non-maturity deposits that are not core deposits, the repricing profile must have only one notional principal cash flow, occurring on the next business day after the calculation date, unless APRA approves an alternative treatment.

An ADI must choose the repricing date of each notional principal cash flow of an OPI item as the earliest date at which:

the ADI has the right to change the interest rate on the principal, or the rate is contractually required to be reset in line with an external benchmark; or

the cash flow will be paid, based on:

if the ADI designates the OPI item to have a contractual repricing profile, an assumption that all principal payments occur at the contractually scheduled dates;

if the ADI designates the OPI item to have a behavioural repricing profile, an assumption that the timing of all principal payments will be in line with best estimate expectations in the case of payments that do not attract economic adjustments for the impact of breaking term, and with the contractually scheduled dates for payments that would otherwise attract such economic adjustments. [7]

[7]
An economic adjustment on early repayment (prepayment) of principal restores the ADI’s position to what it would have been if the principal prepaid had remained unpaid until contractually scheduled. A behavioural repricing profile is intended to reflect the interest-rate sensitivity of the item, given expected payment behaviour. Hence prepayments that are economically adjusted are effectively ignored by treating them as if they did not occur.

An ADI must designate an OPI item to have a repricing profile that is:

contractual for a deposit, unless agreed otherwise with APRA; and

behavioural for all non-deposit items, except that:

contractual may be used if significant deviation from the contractual repricing profile is not expected; and

contractual must be used if there is insufficient relevant data on which to base a behavioural repricing profile.

Where an ADI has designated as a non-market-related item any non-linear derivative such as swaptions, caps or floors, whether stand-alone or embedded in other instruments, the ADI must use a method that APRA has explicitly approved to measure IRRBB on that item.

An ADI’s repricing assumptions form part of its approved IRRBB model and must be clearly documented, conceptually sound, reasonable and, except where compelling reasons are provided to do otherwise, consistent with historical experience.

APRA may review the appropriateness of an ADI’s repricing assumptions and may require the ADI to use different assumptions for the purpose of determining its IRRBB capital charge.

Shorter and longer assumptions

The shorter and longer assumptions are used to take account of the most common sources of optionality risk where customer payments differ from what was assumed in a behavioural repricing profile. These assumptions must be the same as the central assumptions for all items except fixed-rate assets, rate locks and core deposits, for which the differences are:
optionality risk optionality risk – means the risk of loss in earnings or value due to cash flows varying from what an ADI had assumed, caused either by customers exercising stand-alone or embedded options differently from how the ADI had assumed they would, or by the operation of caps, floors and similar mechanisms that automatically adjust interest payments;

for notional principal cash flows:

each prepayment rate that is used in determining the repricing profile for fixed-rate, non-market-related assets must be determined as:
Where is the corresponding prepayment rate used in the central assumptions, is the highest possible prepayment rate, and the factor is specified in Table 1;

each drawdown rate that is used in determining the repricing profile for a rate lock must be determined as:
where is the corresponding drawdown rate used in the central assumptions and the factor is specified in Table 1; rate lock rate lock – means a guarantee by an ADI that a customer may draw down a loan no larger than a nominated limit, at a specified fixed or capped rate, before a nominated expiry date; and

for a core deposit, the notional principal cash flow at any date that is more than one business day after the calculation date is:
where is the corresponding notional principal cash flow for that date in the central assumptions, is specified in Table 1 and the balance of the principal is assumed to reprice on the next business day after the calculation date;

and

all notional interest cash flows must be recalculated to be consistent with the revised notional principal cash flows, in accordance with paragraph 27 of this Attachment .

Table 1: Behavioural optionality factors
Repricing Assumptions
:
Shorter
Longer
Prepayment modification factor
1.2
0.8
Drawdown modification factor
0.8
1.2
Withdrawal factor
0
0.1

Additional optionality risk

An ADI must assess, at inception and at least annually, any risk to which it is exposed to from sources of optionality risk not captured by paragraphs 18 or 34 of this Attachment and determine whether the potential loss from all such sources is material. Where the loss is assessed as material, the ADI must extend its approved IRRBB model to determine a capital charge for those losses, which is the optionality capital charge. That capital charge must meet a soundness standard whereby it is no less than the 97.5 per cent expected shortfall from all such sources over a one-year period. An ADI must also assess new products and variations of existing products as to whether they introduce material additional optionality risk.

For each independent review conducted in accordance with paragraph 61 of this Prudential Standard , an ADI must assess the materiality of its exposure to sources of optionality risk that are not covered by its approved IRRBB model.