Modelling basis and optionality risksModelling basis and optionality risks

Modelling basis and optionality risks

1. An ADI that does not have APRA’s written approval to exclude basis and/or optionality risks from its IRRBB capital requirement and does not have a risk measurement model for these risks, must use a method approved by APRA, in writing, for determining an appropriate amount of regulatory capital for those risks.
2. To the extent possible, the data sets and assumptions used for modelling repricing and yield curve risks and optionality and basis risks should be consistent.
3. An ADI’s internal model for basis risk must explain the historical variation of margins between product interest rates and the implied cost of funds. In addition, the requirements regarding correlation assumptions detailed in paragraph 8 of this Attachment must be met.
4. An ADI’s internal model for optionality risk must accurately capture the unique risks associated with optionality, including the non-linear price characteristics of implicit option positions.
5. An ADI’s internal model may require assumptions about the behaviour of its customers when measuring the capital requirement for basis and optionality risks. Some of these assumptions, including those related to prepayment rates on fixed-rate loans, will be embodied within the ADI’s repricing assumptions. Additional behavioural assumptions may be required for the purpose of measuring optionality risk, such as the volatility of prepayment rates or the relationship between those rates and interest rates. The measurement of basis risk will also require assumptions to be made about the variation of the ADI’s customer product rates around the implied cost of funds. These types of assumptions must be clearly documented by the ADI, including reference to the data on which the assumptions rely.