Guidelines on sound management practices and reporting concerning interest rate risk arising from non-trading activities

NBB_2018_32 – 11 December 2018 Circulaire – Blz. 1/10 boulevard de Berlaimont 14 – BE-1000 Brussels Phone +32 2 221 37 40 – fax + 32 2 221 31 04 Company number: 0203.201.340 RPM (Trade Register) Brussels www.bnb.be Circular Brussels, 11 December 2018 Reference: NBB_2018_32 Contact person:
Van Tendeloo Brenda tel. +32 2 221 51 74 – fax +32 2 221 31 04 brenda.vantendeloo@nbb.be Guidelines on sound management practices and reporting concerning interest rate risk arising from non-trading activities Scope This circular is applicable to Belgian credit institutions, institutions equivalent to settlement institutions, and financial holding companies. They are hereinafter referred to as “the institutions”. The principles and criteria regarding the supervisory review and evaluation process mentioned below essentially apply on a consolidated as well as on a non-consolidated basis. Summary/Purpose With effect from 30 June 2019, this circular shall replace circular NBB_2015_24 on sound management practices concerning interest rate risk arising from non-trading activities and shall transpose the guidelines of the European Banking Authority (EBA) of 19 July 2018 concerning the management of interest rate risk arising from non-trading activities into the Belgian prudential framework. Enclosed as an annexe is the full text of the EBA guidelines of 19 July 2018, with the exception of Section 4.5 on the specific requirements for calculation of the prudential outlier test. Pending changes, following the new EBA guidelines of 19 July 2018, to be made by the ECB, as head of the Single Supervisory Mechanism, to reporting requirements on the outlier test for institutions identified as systemically important within the SSM, the requirements regarding the prudential reporting remain unchanged. In accordance with the EBA guidelines, the requirement to monitor and assess credit spread risk for institutions with SREP categories 3 and 4 is postponed until 31 December 2019.

Circular – Page 2/10 NBB_2018_32 – 11 December 2018 Dear Madam Dear Sir In compliance with Articles 142 and 143 and Articles 7 and 8 of Annex I of the Law of 25 April 2014 on the status and supervision of credit institutions (hereinafter the Banking Law), with this circular the NBB clarifies the principles and criteria on which it bases its supervisory review and evaluation process concerning the management and hedging of interest rate risk arising from non-trading activities (hereinafter ‘interest rate risk in the banking book – IRRBB’) of an institution. This circular hereby replaces Chapter 1 of circular PPB 2006-17-CPB. The supervisory review and evaluation process of the supervisor considers both qualitative (adequacy of the institution's risk management) and quantitative (level of the risk actually incurred) concerns about IRRBB. The supervisor's evaluation of IRRBB based on the principles and reporting described in this circular shall as such serve as the basis for the NBB's Supervisory Review and Evaluation Process (SREP) for those institutions designated as less significant within the Single Supervisory Mechanism (SSM), and shall also contribute to the ECB's supervisory review and evaluation process for the significant institutions directly supervised by the ECB since 4 November 2014. The supervisor hereby integrally adopts the guidelines of the European Banking Authority (EBA) of 19 July 2018 regarding the management of interest rate risk arising from non-trading activities, as entered in Annex 1, with the exception of Section 4.5 on the specific requirements for the prudential outlier test. The requirements regarding the prudential reporting remain unchanged for the time being, pending changes to be made by the ECB as head of the SSM, for institutions identified as systemically important within the SSM, to reporting requirements on the outlier test and the interest rate risk associated with non-trading activities in general, following the new EBA guidelines of 19 July 2018. These requirements are included in
Part 2 of this circular and are in accordance with Part 4 of circular NBB_2015_24.
It is stressed that IRRBB is still regarded as a Pillar 2 risk, which is expected to be adequately managed, evaluated and capitalised internally, whereas prudential reporting aims to compare IRRBB across different institutions and, by doing so, to detect any prudential outliers. Consequently, the prudential reporting is only one element the supervisor will use to assess IRRBB in his Supervisory Review and Evaluation Process (SREP) and to determine a possible Pillar 2 capital surcharge for this or to undertake other prudential actions (see Articles 149 to 154 of the Banking Law).

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1. EBA guidelines concerning the management of interest rate risk arising from non-trading
   activities
   When supervising and evaluating the efficiency of the management of interest rate risk arising from non￾trading activities, the supervisor will mainly monitor compliance with the EBA guidelines1, as well as with the relevant Basel Committee guidelines2. To do so, the NBB is adopting the full text of the EBA guidelines of 19 July 2018 on interest rate risk arising from non-trading activities, with the exception of Section 4.5 on the specific requirements for calculation of the prudential outlier test. The EBA guidelines include 6 main sections concerning:

1. Determination of the subject, scope and definitions, whereby the current Guidelines now also
   include credit spread risk, in contrast to the EBA Guidelines of 2015. The requirement to monitor and assess credit spread risk for institutions with SREP categories 3 and 4 is postponed until 31 December 2019.
2. General requirements.
3. Identification, calculation and allocation of the internal capital assigned to IRRBB, which should
   be commensurate to IRRBB, measured by means of internal calculation methods, taking into account both economic value and earnings sensitivity.
4. Measures and guidelines on internal governance related to IRRBB management.
5. The measurement of IRRBB, which should be based on both economic value and earnings
   sensitivity on the basis of the different shock and stress scenarios that consider changes in the slope and shape of the yield curve, as well as changes in the relationship between various yield curves (basis risk), including the six prescribed scenarios, namely (1) a parallel increase, (2) a parallel decrease, (3) a steeper interest curve, (4) a flatter interest curve, (5) a rise in short-term interest rates, and (6) a fall in short-term interest rates. Guidelines are also given on the calculation and monitoring of interest rate risk resulting from derivative positions.
6. The prudential outlier test, which must be reported to the supervisor in accordance with Article
   98 (5) of Directive 2013/36/EU (CRD), transposed into Belgian law by Article 143, §1, 12° of the Banking Law. The supervisor assumes that every institution, when outlining its policy, shall take these EBA guidelines on management of interest rate risk arising from non-trading activities into consideration and establish a documented and argued view on them that is adapted to the nature, size, complexity and risk profile of the institution’s activities. In principle, the supervisor expects IRRBB to be managed by the institution on both a (sub)consolidated and non-consolidated basis. Within the context of IRRBB, an approach on a consolidated basis means, among other things, that an institution, as a parent company of a group, has a clear view on the scope of the total IRRBB of the entire group, as well as of the location within the group (parent company, individual subsidiaries) where those risks are situated. The way in which the 'consolidated' IRRBB of the entire group is measured can be based on data actually 'consolidated for accounting purposes' to which an internal measurement method is then applied, but may also take the shape of an 'aggregation' of internal measurement results for the group's separate entities. 1 EBA/GL/2018/02, “Guidelines on the management of interest rate risk arising from non-trading activities”, 19 July 2018 (see Annex 1). 2 Basel Committee on Banking Supervision, “Standards, Interest rate risk in the banking book”, April 2016.

Circular – Page 4/10 NBB_2018_32 – 11 December 2018 For the review of interest rate risk management by institutions belonging to a group, the supervisor also considers the dimension of the group in which interest rate risk management is based. Notwithstanding the fact that an institution’s interest rate risk management is based on the group's interest rate risk management policy, the institution concerned should develop suitable management practices on its own level. Institutions are expected to manage their interest rate risk positions on the basis of both economic value and earnings sensitivity, and to do so in relation to different possible interest rate scenarios, including a persistently low interest rate environment.
2. Reporting obligations
2.1. Reporting of internal calculations
Institutions shall keep a description and the necessary documents regarding their own indicators they use and report internally for the management of IRRBB, calculated according to internally defined methods, interest rate scenarios and assumptions, for economic value sensitivity on the one hand and earnings sensitivity on the other, at the disposal of the supervisor. They also keep the periodic results of these indicators at the supervisor's disposal. If necessary, the supervisor may request individual institutions to report these results periodically to him outside the usual periodic reporting circuits.
2.2. Periodic prudential reporting obligations
Institutions with a relevant banking book are subject to the periodic reporting obligations as described in Sections 2.2.1 and 2.2.2 of this circular and in its Annexes 2 (reporting table 90.30) and 3 (comment on reporting table 90.30). For institutions equivalent to settlement institutions, the supervisor may decide on an individual basis that these reporting requirements shall not apply to an institution if its non-trading activities are de minimis3 or if the supervisor assesses the interest rate risk associated with the non-trading activities of that institution as sufficiently mitigated to justify a departure from the reporting requirements. Within the context of this circular and of its related reporting obligations, the following definitions apply:
The ‘banking book’ is the whole of the institution's interest bearing assets that are not part of the trading book, including off-balance sheet positions with an already fixed interest rate and short-term Treasury positions outside the trading book. For the definition of trading book, see the prudential definition of trading book in CRR4 Art. 4 Section 1 (86). Consequently, instruments held with trading intentions and the hedging of these positions pertain to the trading book. Thus, instruments not held for trading intentions and the hedging of these positions pertain to the banking book. The accounting treatment of the instruments does not play any part in this respect. Non-interest bearing assets (including the non-interest-bearing elements of an institution's regulatory capital) are not part of the banking book. Any interest-bearing elements of the institution's regulatory capital pertain to the banking book. 3 The size of the non-trading activities is considered to be de minimis if the total of the non-trading activities is normally less than 5% of the total assets and EUR 15 million. These thresholds are inspired by the provisions of Article 94 of the CRR, which defines de minimis thresholds in relation to the size of the trading book. 4 Capital Requirements Regulation (CRR), that is Regulation (EU) No. 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No. 648/2012.

NBB_2018_32 – 11 December 2018 Circular – Page 5/10 The ‘economic value’ of the banking book is the algebraic sum of the prospective cash flows of the banking book's assets, discounted at the present rate (swap rate, see Section 2.2.2.3 of this circular) and in accordance with their interest rate maturity. ‘Interest income’ is the difference between interest income and interest expenses related to the banking book. However, for institutions using International Financial Reporting Standards (IFRS), the concept of interest income should be used in a broader sense, so as to also take into account the changes in the real value of the banking book's items that are handled via the profit-and-loss account.
2.2.1. General requirements

1. The institutions follow their own internal methodology for the calculations, but in doing so, they should
   use the interest rate scenarios set by the supervisor and standard assumptions for behavioural items such as savings and sight deposits. These standard assumptions are merely intended for reporting purposes and should not be perceived as assumptions to be used obligatorily by institutions for their own internal risk management. Likewise, the supervisor has no wish whatsoever to intervene in the individual institutions' reinvestment policy of said instruments in assets with an appropriate interest adjustment date.
2. Reporting table 90.30 is drawn up on a (sub-)consolidated basis. All bank subsidiaries and branches
   falling within the prudential consolidation scope should also be included in the consolidated prudential reporting on IRRBB, except for those entities that are insurance companies. Institutions with a relevant banking book that are not subject to consolidated supervision should report on a non-consolidated basis. An institution that reports reporting table 90.30 on a consolidated basis, does not have to report the table on a non-consolidated basis, except on explicit request by the NBB.
3. Although the interest rate risk associated with insurance activities, pension plans for employees or
   group insurance can be of a material nature, and should if necessary be duly monitored and managed by the institution, these activities shall not be included in the prudential reporting as the interest rate risk profile of these activities usually differs strongly from the other banking book positions.
4. With regard to the inclusion of the positions, see the above-mentioned definition of banking book. All
   trading book positions should be excluded. All banking book positions, except those mentioned under item 3), should be included, including short-term Treasury positions and all interest-bearing off-balance￾sheet positions of a non-trading nature and with a pre-fixed interest rate. The inclusion of off-balance￾sheet positions not only presumes the inclusion of amounts of funds borrowed but still to be delivered, but also the inclusion of loans granted but not yet paid out and of other commitments of the institution regarding the supply of fixed-interest-rate loans, including binding credit offers and credit lines with pre￾fixed interest rate. The inclusion of these off-balance-sheet positions requires duly founded and documented assumptions or assessments regarding the fulfilment of these positions in the different scenarios. In this respect, reference is made to the proportionality principle, with the expected refinement of the assessments and models depending on the institution's size, the complexity of its activities and the materiality of the positions.

Circular – Page 6/10 NBB_2018_32 – 11 December 2018
5) When calculating the economic value, interest income and economic value and earnings sensitivity,
institutions should consider the value of all automatic options and the way in which their value changes in the different interest rate scenarios. Automatic options are to be understood as those options that will almost certainly be fulfilled if this is in the financial interest of their holder. Automatic options can be explicit options as well as options embedded in the characteristics of certain products. The 11bp legal floor on regulated savings accounts is also an automatic option that should be taken into account in the calculations. The impact of interest rate changes on the (intrinsic) value of these options should be fully covered in the reporting. Moreover, the proportionality principle is also applied here, with bigger and more complex institutions being expected to also take into account the time value of an option, when relevant. Institutions shall consistently adhere to a duly founded and documented policy about how they incorporate transactions of an optional nature (both specific option contracts and so-called 'embedded options') in the calculations according to the different scenarios.
6) Also regarding other behavioural optionalities (except for non-maturity deposits: see below), institutions
should make the assessments themselves and incorporate them into the prudential reporting. The proportionality principle is applied with regard to the refinement of these assessments and models. For instance, the following should be taken into account:
a) Early repayments
The institution should take into account the loss of revenue due to early redemption or refinancing of mortgages or other loans for which the loss of margin must not be fully compensated by the customer. Taking into account early repayments should be done dynamically, with the expected number of early repayments (normally) being significantly lower in scenarios with an increasing interest rate than in the baseline scenario, whereas a significantly higher number of early repayments should be taken into account in falling interest rate scenarios. b) Term deposits Also for term deposits that can be withdrawn with only a partial remuneration of the costs incurred by the institution, these early withdrawals should be estimated and taken into account in the calculations of the economic value, interest income and economic value and earnings sensitivity, with the estimated early withdrawals varying according to the scenario.
7) All hedged positions and hedging operations pertaining to the banking book should be included in the
prudential reporting, since the reporting should not only reflect a correct assessment of the economic value and earnings sensitivity, but also a correct assessment of the economic value and interest income. In addition, a hedging instrument can barely be used to cover both economic value and interest income.
8) Non-interest-bearing assets and equity elements are not part of the banking book and should therefore
be excluded.
9) Commercial margins should be included in the calculation of the economic value and interest income.
In other words, cash flows should be included at external customer rates. As the inclusion of commercial margins can increase the economic value sensitivity of institutions with large commercial margins, the institutions can, additionally and on a voluntary basis, also report the economic value, excluding the commercial margins, therefore at swap rate on production/repricing date (except for non-maturity deposits, which should be included at external customer rates).

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10) The table is reported in euros, for the entire banking book. In accordance with the Basel framework of
20045 and 20166, a separate calculation should be made for each currency in which the positions exceed 5% of the non-trading assets or liabilities. Consequently, positions in different currencies in which such material positions are held, cannot be simply compared, as this would presume that interest rates in the different currencies are perfectly correlated. For each currency in which the positions exceed 5% of non-trading assets or liabilities a separate calculation of economic value and earnings sensitivity should be made. Subsequently, only losses (in economic value and interest income) in the foreign currency are taken into account and are added to the results in euros in each of the scenarios. Positions in currencies that are less than 5% of non-trading assets or liabilities should be converted into euros and should be included in the calculations in euros. The cumulative outcome should be reported in table 90.30.
11) In the simulation of interest rate shocks, prudential reporting takes into account a floor interest rate of
0%. Negative interest rates should be replaced in the calculations of the different scenarios by an interest rate, being the minimum of 0% and the (negative) interest rate of the instrument in the basis scenario of unchanged interest rates.
12) Reporting frequency is quarterly.
2.2.2. Economic value sensitivity
Institutions should be able to provide information on the economic value of their banking book calculated according to their own internal methodology and considering the requirements mentioned under 2.2.1, but in doing so, they should use - for the purpose of the outlier approach - the interest rate scenarios imposed and standard assumptions for behavioural items such as savings and sight deposits. The proportionality principle is applied for the calculation of economic value sensitivity. More specifically, bigger and more complex institutions are expected to make the calculations on a 'full revaluation' basis. Small and modest institutions can make the calculations on a 'duration' basis. In particular, the calculations of economic value sensitivity in terms of economic value should meet the following requirements:
2.2.2.1. Assumptions for behavioural items
For the treatment of savings and sight deposits, institutions shall use the following required assumptions concerning the interest rate adjustment date:
§ interest-insensitive sight deposits (ordinary sight deposits with very low (or no) interest remuneration which is not associated with market interest rate movements): interest rate adjustment after five years; § interest-sensitive sight deposits (sight deposits whose interest rate is being adjusted fully and immediately to market interest rate movements): immediately adaptable interest rate; § semi-interest-sensitive sight deposits (sight deposits with an interest remuneration which, although higher than the remuneration for interest-insensitive sight deposits, does not change immediately and fully along with market interest rate movements): interest rate adjustment after two years; § regulated savings deposits (savings deposits that meet the conditions as stipulated by Art. 2 of the
Annex to the Royal Decree of 27 August 1993 implementing the Income Tax Code 1992): interest rate
adjustment after two years.
5 Basel Committee on Banking Supervision, “Principles for the Management and Supervision of Interest Rate Risk”, July 2004. 6 Basel Committee on Banking Supervision, Standards, Interest Rate Risk in the banking book, April 2016.

Circular – Page 8/10 NBB_2018_32 – 11 December 2018 Consequently, the deposits concerned should be repriced entirely on the above-mentioned interest rate adjustment date. The supervisor shall regularly inspect these uniform assumptions concerning the interest rate adjustment date of savings and sight deposits and adjust them if necessary - still for reporting purposes - by means of a circular.
2.2.2.2. Interest rate scenarios
Besides the scenario of unchanged interest rates, the calculations follow six stress scenarios of immediately implemented standardised assumed parallel interest rate movements: three parallel interest rate rise scenarios and three parallel interest rate fall scenarios. The scope of the standardised assumed parallel interest rate movement in the different scenarios amounts to 100, 200, and 300 basis points respectively. Depending on the prevailing interest rate environment, the most appropriate interest rate movement at that time of those three assumed interest rate movements will be used in the 'outlier' detections process. In principle, the scenario of a 200-basis-point interest rate movement will be used, but, taking into account the prevailing interest rate environment and particularly the level of interest rates and their observed volatility, the supervisor can opt for the use of another reported scenario. For his choice, the supervisor will test, among other things, to what degree the chosen scenario is in keeping with the 1° and 99° percentile of observed interest rate movements, using a minimum of five years of observation and a one-year holding period. If the 200-basis-point interest rate movement turns out to be smaller than this observed interest rate movement, the latter will be used in the 'outlier' detection process.
2.2.2.3. Discount rate
Institutions are to use a plain vanilla swap rate as discount rate, for instance with the overnight, 3 or 6 months rate as a floating leg. For positions with a repricing term lower than the shortest available fixed leg of the applied swap curve, the institutions should use the prevailing interbank rates. These rates should then be converted into zero coupon rates in order to obtain the discount rate.
2.2.3. Earnings sensitivity
With regard to interest income and earnings sensitivity, it should be noted that in line with the above￾mentioned definition of interest income, the concept of interest income should be used in a broader sense for institutions using IFRS, so as to also take into account the changes in fair value that are handled via the profit and loss account. At the same time, the basis for the calculation of interest income in the baseline scenario and in the stress scenarios should be the same as the one for the calculation of interest income of the past 12 months, which should be reconcilable with interest income in FINREP. In particular, the calculations of earnings sensitivity in terms of interest income should meet the following requirements:
2.2.3.1. Assumptions for behavioural items
The institution uses the following assumptions concerning the interest rate adjustment date of behavioural items:
§ interest-insensitive sight deposits: interest rate adjustment after five years; § interest-sensitive sight deposits: immediately adaptable interest rate; § semi-interest-sensitive sight deposits: interest rate adjustment after six months; § regulated savings deposits: interest rate adjustment after six months.

NBB_2018_32 – 11 December 2018 Circular – Page 9/10 The supervisor shall regularly inspect these uniform assumptions concerning the interest rate adjustment date of savings and sight deposits and adjust them if necessary - still for reporting purposes - by means of a circular.
2.2.3.2. Interest rate scenarios
Besides the scenario of unchanged interest rates, the calculations follow six stress scenarios of gradually implemented standardised assumed parallel interest rate movements: three parallel interest rate rise scenarios and three parallel interest rate fall scenarios. The scope of the standardised assumed parallel interest rate movement in the different scenarios amounts to 100, 200, and 300 basis points respectively. The different scenarios of parallel interest rate movements assume gradually implemented interest rate movements, one quarter of which is adjusted immediately, one quarter after three months, one quarter after six months and one quarter after nine months. For semi-interest-sensitive sight deposits and regulated savings deposits, the institution bases itself on assumed interest rate movements which amount to only 70% of the standardised assumed interest rate movements. Consequently, an interest rate rise of 200 bp would mean that for regulated savings deposits (with a 6-month interest rate adjustment date) an interest rate increase of 105 bp is taken into account after 6 months (75%200bp70%) and an additional 35 bp after 1 year (25%200 bp70%).
2.2.3.3. Assumptions for the interest rate to be applied on repricing
In order to calculate the expected interest income result over the next 3 years in the baseline scenario (unchanged interest rates), institutions should apply, for new positions replacing positions which have come to maturity (see Section 2.2.3.4 below), the spot interest rate for customers on the reporting date (swap rate and commercial margin on reporting date). For existing positions that are repricing, the spot swap rate on the reporting date plus the historic commercial margin should be applied in the baseline scenario. In order to calculate the interest income result among the different stress scenarios, the relevant interest rate shocks should be applied on these spot interest rates.
2.2.3.4. Assumptions for the replacement of positions coming to maturity (static balance sheet)
Calculations concerning interest income should be based on a static balance sheet, with the current balance sheet composition being maintained over the surveyed horizon of 3 years, and the positions coming to maturity being replaced by similar positions ('replacement growth'). Since the initial maturity of individual positions cannot always be discovered, 'replacement growth' can be applied on a portfolio level. The division into different portfolios should, however, be sufficiently granular (at least per type of product), with a clear distinction between, among other things, mortgage loans to households, consumer loans, investment loans to large enterprises, investment loans to SMEs, cash credit, interbank claims, hedging transactions, etc. The total portfolio volume should remain constant. For each portfolio, the institutions should replace positions coming to maturity (both balance-sheet and off-balance-sheet items, within the 3-year horizon for interest income) by new positions, with the repricing term of these new positions reflecting the current production for this portfolio. The average repricing term for each portfolio should remain as constant as possible. If this should strongly change the average repricing term of that portfolio, then this should be motivated and documented sufficiently and be forwarded to the supervisor.

Circular – Page 10/10 NBB_2018_32 – 11 December 2018 On the basis of the reported data, the supervisor can calculate additional indicators, for instance in relation to other profitability data of the institution. A copy of this circular will be forwarded to the supervisory director(s), certified auditor(s) of your institution. Yours faithfully J. Smets Governor Annexes - only available on www.nbb.be:
1 EBA Guidelines of 19 July 2018 on the management of interest rate risk arising from non-trading activities 2 Reporting table 90.30 3 Comment on reporting table 90.30