Modelling repricing and yield curve riskModelling repricing and yield curve risks

Modelling repricing and yield curve risks

1. For the purpose of determining the IRRBB capital requirement for repricing and yield curve risks, an ADI’s internal model must measure the maximum potential change in the economic value of the banking book (EVBB), as a consequence of changes in interest rates, for a 99 per cent confidence level and over a one-year holding period (consistent with the soundness standard detailed in paragraph 30 of this Prudential Standard).

2. The economic value of an individual banking book item is calculated as the net present value as at the beginning of the holding period, of expected future notional principal and interest cash flows. Notional cashflows should be discounted using the actual and simulated wholesale market interest rates as appropriate. EVBB is the sum of the economic value of all banking book items.

3. An ADI’s internal model must estimate the 99th percentile of the distribution of EV0 minus EV1 where:

4. EV0 is EVBB minus an earnings offset (refer to paragraph 17 of this Attachment). In this case, EV0 and EVBB are both calculated using the discount rates prevailing at the beginning of the holding period; and

5. EV1 is EVBB minus an earnings offset (refer to paragraph 17 of this Attachment). In this case, EV1 and EVBB are both calculated using the discount rates simulated as prevailing at the end of the holding period.

EV0 and EV1 are calculated on the same items using the same outstanding balances and repricing dates.[7]

1. The principal component of the notional cash flows must be derived using an ADI’s repricing assumptions. The interest components relating to a principal payment must be calculated using historical wholesale rates (refer to paragraphs 15 and 16 of this Attachment).[8]
2. For banking book items with defined inception and principal payment dates, the historical wholesale rate applicable to a principal payment is the wholesale market rate applicable to a payment on the repricing date, taken from the yield curve applicable on the inception date of the instrument incorporating the principal payment. APRA will review the appropriateness of an ADI’s choice of wholesale rates for the purposes of this paragraph and paragraph 12 of this Attachment and may, in writing, determine that the ADI must use different rates for the purpose of determining its IRRBB capital requirement.
3. For banking book items that do not have defined inception or principal payment dates, assumptions must also be made about inception dates. In such cases, the historical wholesale rate applicable to a principal payment will be determined as described in paragraph 15 of this Attachment but using the inception and principal payment dates specified in the ADI’s repricing assumptions.