Banks face a push from international regulators for stiffer rules on the capital needed to handle an increase in interest rates.
The Basel Committee on Banking Supervision is weighing updating its standards for capturing interest-rate risk on assets banks plan to hold to maturity, Stefan Ingves, the regulator's chairman, said in an interview.
"We are working on interest-rate risk in the banking book," Ingves said on March 27 in Frankfurt. "We are looking into that presently and we hope to put out something in this field fairly soon."
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Global central banks have pushed interest rates to historic lows in a bid to counter the worst financial crisis since the Great Depression. The European Central Bank (ECB), as well as monetary policy chiefs in Denmark and Switzerland, are among those to have pushed some rates below zero in a bid to spur bank lending and stimulate economic growth.
Regulators are concerned that some banks may not be prepared for when the monetary policy tide turns and rates start to increase.
U.S. Federal Reserve Chair Janet Yellen said last week that interest rates will probably be raised in 2015 and made the case for a cautious approach to subsequent increases. Bank of England (BOE) Governor Mark Carney said that the next move on rates by the BOE will probably be an increase, "because we will need some limited and gradual increases in interest rates to bring inflation back to target."
One of the reasons for the Basel committee looking into this issue now is "the general level of interest rates in the world," Ingves said. Rates "will go up," and "not in a synchronized way," he said.
The Basel committee brings together regulators from 30 nations to set bank capital requirements. Its members include the BOE and the U.S. Federal Reserve.
Capital requirements are a measure of banks' financial strength. They set minimum rules on how far banks must fund themselves through equity and other sources that can absorb unforeseen losses.
Basel rules already include binding capital requirements for interest-rate risk on assets held in banks' trading books.
For the banking book, international standards are currently limited to a system whereby banks regularly report to their national supervisors on risk levels. The supervisors then take decisions on whether more capital, or a reduction in the size of the position, is needed.
Binding Rules
This is known as a so-called Pillar 2 process, compared with the setting of binding rules, known as Pillar 1.
"The issue before the committee going forward will be whether to, and how to, move toward a Pillar 1, or whether we should move toward a more rigorous Pillar 2 treatment," Ingves said.
Types of interest rate risk in the banking book include banks getting a relatively low interest rate on investments such as mortgages, while being under competitive pressure to offer higher rates to depositors. Others include banks being caught out by changes in the relationship between interest rates on short- and long-term debt.
"Interest rate risk in the banking sector is currently extremely high, so any specific capital charge would be high and costly for the banks," Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc., said in an interview. "Analysts would instantly price any new rule into their banking forecasts."
A split has emerged in the Basel committee between European and U.S. regulators over how far to go beyond current measures, according to four people with knowledge of with the matter.
Many European Basel members are keen to move toward tighter global standards on risk measurement and on the amount of capital required. This has put them at loggerheads with the U.S., which wants to stay closer to the current approach.
The file was discussed at a meeting of the committee earlier this month in Basel. A range of possible solutions have been discussed, including designing a more constrained type of Pillar 2 approach, the people said.
The committee is set to publish a consultation paper in the next few weeks setting out both a Pillar 1 option and a more constrained Pillar 2, one of the people said.
The work on interest-rate risk in the banking book comes as the Basel committee seeks to finish off the remaining elements of a post-crisis rule overhaul that has been in full swing since 2009. The committee plans to complete work on many outstanding rule revisions by the end of 2016.
–With assistance from Johan Carlstrom in Stockholm.
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