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];
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
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
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]
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]
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.