Banks Face Tighter Rules on Interest Rate Risk

Global regulators beefed up rules for tackling interest-rate risk in banks' loan books, but stopped short of imposing binding capital requirements after fierce opposition from the financial industry.

The Basel Committee on Banking Supervision said the risk posed by changes in interest rates is “material,” especially at a time when rates “may normalize from historically low levels.” The updated rules published on Thursday pertain to customer loans and other assets that lenders expect to hold for long periods, or to maturity, and whose current value can vary when rates change.

Banks pilloried a proposal last year to replace the existing supervisor-led approach with minimum capital requirements set centrally by the Basel Committee, whose members include the U.S. Federal Reserve and the European Central Bank. The regulator “noted the industry's feedback,” and concluded that the “heterogeneous nature” of interest-rate risk in the banking book was “more appropriately captured” by bolstering the current system.

The new standards “reflect changes in market and supervisory practices since the principles were first published in 2004, which is particularly pertinent in light of the current exceptionally low interest rates in many jurisdictions,” the Basel Committee said. The ECB is among central banks that have pushed some rates below zero in a bid to spur bank lending and revive inflation.

'Capital Consequences'

In setting out the new rules, the Basel Committee said banks “should also consider negative interest rate scenarios and the possibility of asymmetrical effects of negative interest rates on their assets and liabilities.” It didn't go further into the issue of negative rates.

The regulator provided no estimate of the impact the rules would have on total capital requirements, but Uldis Cerps, executive director for banking at Sweden's Finansinspektionen regulator, said earlier this month that “irrespective of the path chosen, there will be capital consequences for banks in respect of interest rate risk.” The FSA is a member of the Basel Committee.

The Basel Committee has said that it “will focus on not significantly increasing overall capital requirements” as it wraps up work on its post-crisis bank-rule overhaul this year.

One of the main changes in the new rules is that a “stricter threshold” is applied for identifying “outlier banks,” those that “must be considered as potentially having undue” interest rate risk in their banking books, the regulator said. The threshold has been reduced from 20 percent of a bank's total capital to 15 percent of Tier 1 capital.

'Excessive Risk'

That will make more banks subject to supervisory scrutiny. When a review of a bank's interest rate risk exposure “reveals inadequate management or excessive risk relative to capital, earnings, or general risk profile, supervisors must require mitigation actions and/or additional capital,” the regulator said.

The committee altered the current supervisor-led approach to include guidance on the “shock and stress scenarios” and modeling assumptions that banks use to measure risk. Disclosure requirements have also been enhanced to “promote greater consistency, transparency, and comparability,” the regulator said.

An updated standardized approach to measuring interest rate risk can also be prescribed by supervisors if they find banks' own assessments to be insufficient.

Large, internationally active banks are expected to implement the new standards by 2018. Supervisors can also apply them to other firms.

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