F. Interest Rate Risk in the Banking Book (IRRBB)

C 52/2017 STA Effective from 1/4/2021

83. IRRBB is the risk of loss in the banking book caused by changes in interest rates. Interest rate risk can arise both in the banking book and/or the trading book. While interest rate risk in the trading book is addressed under the Pillar 1 market risk framework, the interest rate risk in the banking book should be addressed under Pillar 2. Conventional banks refer to this risk as IRRBB while Islamic banks are exposed to the analogous risk called profit rate risk in the banking book (PRRBB).

84. Each bank should define a risk appetite pertaining to IRRRB that should be approved by the Board and implemented through a comprehensive risk appetite framework, i.e. policies and procedures for limiting and controlling IRRBB. Each bank should have a process supported by adequate policies to manage IRRBB appropriately. This involves, as for any other risk, comprehensive identification, measurement, reporting, monitoring, and mitigation.

85. The measurement process should be based upon several existing Standards and Guidance:

(i)	Central Bank “Standards re Capital Adequacy of Banks in the UAE - ICAAP Standards”;
(ii)	Central Bank “Regulation and Standards re Interest Rate & Rate of Return Risk in the Banking Book” in 2018 (Notice 3021/2018 and Circular 165/2018);
(iii)	Central Bank Model Management Standards and Guidance in 2022 (Notice 5052/2022); and
(iv)	Basel Framework - Interest Rate Risk in the Banking Book (SRP 31).

Measurement

86. The assessment should include all positions of each bank’s potential basis risk, re-pricing gaps, commercial margins, gaps for material currencies optionality, and non-maturing deposits. The quantitative impact analysis should be supported by description and analysis of the key assumptions made by the bank, in particular, assumptions regarding loan prepayments, the behaviour of non-maturity deposits (CASA), non-rated sensitive assets, contractual interest rate ceilings or floors for adjustable-rate items, and measuring the frequency of the interest rate risk in the banking book.

87. DSIBs and other banks with significant interest rate risk (IRR) exposure should compute the economic value of equity (EVE) at a granular facility level, while non-DSIBs may compute EVE at exposure level, which is based upon the summation of discounted gap risk across time buckets, rather than a granular net present value (NPV) estimation at exposure level.

Scenarios

88. For the purpose of capital calibration, each bank should employ the interest rate shock scenarios corresponding to Table 12 of Central Bank Model Management Guidance and table 2 of the SRP 31 for their AED and non-AED positions respectively.

89. In addition to the standard shocks prescribed above, DSIBs and other banks with significant exposure to interest rate risk are expected to apply further shocks/ idiosyncratic scenarios, which will take into account:

•	The bank’s inherent risk profile;
•	Historical shocks experienced by the bank due to market sentiment and corresponding to macro-financial factors; and
•	Additional scenarios prescribed by the Central Bank specifically through supervisory interactions or financial stability processes.

Capital Calculation

90. The capital requirement should be aggregated across all currencies and scenarios conservatively.

91. The estimation of the Pillar 2 capital corresponding to IRRBB should be based on the most conservative loss arising from (i) the change in the economic value of equity (ΔEVE), and (ii) the change in net interest income (ΔNII). The most conservative result should be considered across all the scenarios calibrated by the bank. (In avoidance of doubt, the allocated capital for IRRBB should not be lower than the maximum of the absolute EVE impact and the absolute NII impact: Max(abs(EVE impact), abs(NII impact).

92. The Central Bank considers a bank as an outlier when the IRRBB EVE impact based on the standard parallel shock leads to an economic value decline of more than 15% of its Tier 1 capital. The Central Bank may request an outlier bank to:

(i)	Reduce its IRRBB exposures (e.g. by hedging);
(ii)	Raise additional capital;
(iii)	Set constraints on the internal risk parameters used by a bank; and/ or
(iv)	Improve its risk management framework.

93. Irrespective of the approach or model chosen by the bank, at a minimum each bank should calculate and report IRRBB using the methodology described by the Central Bank Model Management Standards and Guidance.