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a non-maturity deposit, which is a deposit that has no specified maturity date and can be withdrawn at any time without notice; or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 In the set m, containing the elements central, shorter and longer, 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 Repricing assumption m, where, for each possible rate scenario Possible rate scenario s in the distribution of rate scenarios, the prospective loss is equal to:
Formula for calculating the prospective loss for each possible rate scenario s in the distribution of rate scenarios.
PreShockEV subscript jis the EV of item j under the central assumptions, using the values of risk factors at the calculation date;
PostShockEV subscript j,s superscript mis the EV of item j calculated using repricing assumptions Repricing assumption m, together with simulated risk factor values obtained by applying to risk factors at the calculation date, a shock determined for rate scenario Possible rate scenario s in accordance with paragraph 19 of this Attachment;
Augmented banking book is the augmented banking book (see paragraph 28 of this Attachment);
Note that PostShockEV subscript j,s superscript m is a random variable, whereas PreShockEV subscript j is not.
The distribution of each PostShockEV subscript j,s superscript m 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:
Formula for calculating the simulated value of the risk factor to be used in the scenario for a given observation date
where:
Values of the risk factor at the calculation date d, the observation date s and ten business days before the observation dateare 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.