Finalisation of Interest Rate Risk in the Banking Book requirements
To: All authorised deposit-taking Institutions
Interest Rate Risk in the Banking Book (IRRBB) is a material risk for authorised deposit-taking Institutions (ADIs). APRA’s supervisory and policy approach to IRRBB has held the Australian banking system in good stead, successfully navigating last year’s international banking crisis and avoiding the experience of some overseas banks.
Following a series of engagements with industry, with the final consultation in December 2023, APRA is now releasing a response to submissions and the final revised prudential standard and practice guide for IRRBB for ADIs. The final revised Prudential Standard APS 117 Capital Adequacy: Interest Rate Risk in the Banking Book (APS 117) will be effective from 1 October 2025.
The revisions to APRA’s standard are designed to:
- address lessons learned from the large interest rate movements and last year’s international banking crisis;
- create better incentives for ADIs (in particular larger ADIs) in managing their interest rate risk, including raising standards of governance and the measurement of risk; and
- simplify the IRRBB framework and ensuring a proportionate approach across ADIs.
For smaller ADIs, the proposed changes principally reaffirm existing risk management requirements. For larger ADIs, the revisions reduce the volatility over time and variation between ADIs in the calculation of the IRRBB capital charge and is calibrated to not result in a material increase in capital for the industry as a whole.
Consultation process
APRA has undertaken multiple rounds of consultation on its proposals to revise its IRRBB requirements and has engaged with a variety of stakeholders, including ADIs and industry bodies.1 The most recent consultation reaffirmed APRA’s expectation that all ADIs need to manage their material risks, including IRRBB, as required by the existing Prudential Standard CPS 220 Risk Management (CPS 220).
Alongside the proposed revisions to the prudential standard (APS 117), APRA also consulted on the draft revised prudential practice guide (APG 117), draft reporting standards (ARS 117.0 and ARS 117.1) and reporting practice guide (RPG 117) (see separate letter on reporting requirements).
Response to submissions
APRA received five submissions to this most recent consultation, of which one was confidential. Submissions were supportive of APRA’s proposal for non-significant financial institutions (non-SFIs). Most submissions centred on seeking guidance and clarification on the application and interpretation of certain IRRBB modelling requirements specific to Internal Ratings-based Approach (IRB) ADIs. APRA has incorporated additional information in the final revised APG 117 to address the issues raised in submissions. There were no submissions that raised concerns on the final revised APS 117.
Details on the specific comments raised by industry and APRA’s response are provided in Attachment A. The final revised prudential and reporting standards and guides are available at: Interest Rate Risk in the Banking Book.
Maturity profile for shareholders’ equity
In response to industry queries, APRA has revised APG 117 to clarify expectations on assumptions for the maturity profile of shareholders’ equity, which can impact IRRBB exposures materially. APRA has recently engaged with a range of ADIs on practices regarding the management of balance sheet strategies, including the maturity profile for shareholders’ equity. APRA observed inadequate oversight by a number of ADIs of their shareholders’ equity maturity profile choices.
Where an ADI assumes a maturity profile for shareholders’ equity, the final revised APS 117 requires the senior management of an SFI to set such a strategy consistent with the IRRBB risk appetite set by the Board. The final revised APS 117 also requires senior management of an SFI to measure and report risk and performance of its balance sheet strategies to the Board or Board Committee and on a regular frequency.2
While the final revised APS 117 and APG 117 will not be effective until 1 October 2025, it is considered prudent for ADIs to have regard to these revisions and guidance in their ongoing management of IRRBB.
IRRBB capital charge formula
APRA has made minor drafting changes to paragraph 2 of Attachment A to the revised APS 117 to improve the flow of the IRRBB capital charge formula. This does not represent a change in requirements, but rather ensures that the text and formula are consistent between the prudential standard and the Reporting Standard ARS 117.1 IRRBB Capital Charge (ARS 117.1).
Sunsetting of current APS 117
The current APS 117 is due to sunset on 1 April 2025.3 APRA proposes to leave the current APS 117 unchanged at this stage and remake it so that it will continue to apply after 1 April 2025 until the final revised APS 117 is effective on 1 October 2025.
APRA invites feedback on the remake of the current APS 117 by 9 August 2024. Submissions should be sent to ADIpolicy@apra.gov.au. Subject to this feedback, APRA expects to remake the current APS 117 without change as a transitional measure until the final revised APS 117 is effective.
Yours sincerely
Therese McCarthy Hockey
APRA Board Member
Attachment A: Comments raised in submissions and response
This Attachment sets out specific comments raised by industry in submissions to APRA’s 12 December 2023 consultation and APRA’s response to them.
| Issue | Comments received | APRA response |
|---|---|---|
| Requirements for non-SFIs | Submissions welcomed extending certain requirements of APS 117 to non-SFIs and highlighted the importance of including proportionality in the prudential standard and guidance. Some submissions noted that further guidance may be required for small, less complex ADIs. | Paragraph 14 of the final revised APS 117 states that IRRBB is a material risk under CPS 220. As part of its risk management framework, APRA expects a small, less complex ADI to consider the CPS 220 requirements and ensure that it appropriately manages its IRRBB, commensurate with the nature, scale, and complexity of its operations. |
| Embedded loss calculation | Some submissions sought clarification whether the embedded loss calculation includes all banking book items, i.e. both accrual and fair value accounted items or are marked-to-market items excluded. | The final revised APS 117 requires the embedded loss calculation to apply to all banking book items within an ADI’s augmented banking book, which is defined in accordance with paragraph 28 of Attachment A to the final revised APS 117 and includes an earnings offset. For the avoidance of doubt, APRA has provided guidance in the final revised APG 117 to reiterate that all banking book items are to be captured in the embedded loss calculation. For market-related items where the book value is equal to the economic value, this results in a zero value for the embedded loss calculation. |
| Earnings offset | Some submissions questioned if earnings offset should be calculated “as at the beginning of the holding period” or “as if the earnings offset were incepted at the calculation date”. If the latter, then its pricing and valuation would coincide on the same observation date which would imply that earnings offset has a zero value and is effectively excluded from embedded loss. | Paragraph 28 of Attachment A to the final revised APS 117 states that the “earnings offset must be calculated as the economic value, as at the beginning of the holding period, of a notional twelve-month, equally weighted, monthly-moving average portfolio of fixed-for-floating interest rates swaps.” APRA has provided additional guidance in the final revised APG 117, and a list of assumptions APRA expects an ADI to make when calculating the earnings offset. For the avoidance of doubt, the earnings offset has a non-zero value at the calculation date. |
| Maturity of residential mortgage-backed securities (RMBS) | One submission sought clarification for the classification of banking book items and modelling of interest rate risk for RMBS, that the maturity of RMBS refers to the expected maturity and not the legal maturity. | APRA has clarified in the final revised APG 117 that interest rate risk is to be modelled out to the expected maturity for all RMBS. |
| Self-securitisation | Some submissions asked whether wholly owned self-securitisation where the intent is to create a Reserve Bank of Australia (RBA) repo-eligible security for liquidity purposes can be excluded from capital calculations on the basis the underlying instruments are already present in the risk. | APRA has clarified in the final revised APG 117 that wholly owned self-securitisation where the intent is to create an RBA repo-eligible security for liquidity purposes can be excluded from IRRBB capital calculations. |
| Capital underlay | One submission asked whether a capital underlay (i.e. a ‘negative’ overlay) is prohibited under APS 117. | APRA has provided guidance in the final revised APG 117 that capital underlays are not permitted under APS 117. |
| Observation period | Some submissions sought confirmation whether the observation period can be updated more regularly than quarterly and that the quarterly update is only a minimum requirement. | Paragraph 15 of Attachment A to the final revised APS 117 states that (Period B) observation dates within the eight-year observation period are to be updated quarterly. APRA has provided guidance in the final revised APG 117 that ADIs must not update more regularly than quarterly. This is to ensure comparability across ADIs so that all ADIs use the same observation period and update relevant data at the same frequency. |
| APS 117 and public disclosure | Some submissions noted a lag between the commencement of the revised Prudential Standard APS 330 Public Disclosure (APS 330), effective 1 January 2025 and the revised APS 117, which commences 1 October 2025, and questioned if they can defer IRRBB public disclosure requirements under APS 330 (January 2025) until the implementation of the revised APS 117.
| APS 330 (January 2025) require ADIs to make prudential disclosures as set out by the Basel Committee on Banking Supervision (BCBS), adjusted for the Australian context. However, APRA recognises that there may be difficulty for some ADIs to comply with APS 330 (January 2025) requirements ahead of the implementation date of the revised APS 117. Paragraph 20 of APS 330 (January 2025) provides ADIs flexibility in meeting the BCBS disclosure templates, including making modifications to the templates where there are inconsistencies with Prudential Standards. APRA expects ADIs to take a pragmatic approach to IRRBB disclosure in the period between the effective dates of the updated APS 330 and the final revised APS 117. |
Footnotes
1APRA’s consultations related to IRRBB can be found in the link titled "interest rate risk in the banking book" at Revisions to the capital framework for authorised deposit-taking institutions | APRA.
2In finalising APG 117, APRA has clarified that, in meeting the requirements of CPS 220 and appropriate management of IRRBB, it is considered prudent for non-SFIs to also have regard to their choice of the maturity profile of shareholders’ equity. APRA has also clarified that IRRBB risk appetite limit metrics should measure the risks generated by all active and passive balance sheet strategies. A hypothetical portfolio that represents the assumed maturity profile of shareholders’ equity should not be included within the measurement of IRRBB: this ensures the investment strategy is appropriately captured.
3Banking (prudential standard) determination No. 10 of 2012 - Prudential Standard APS 117 Capital Adequacy: Interest Rate Risk in the Banking Book (Advanced ADIs).