APRA moves to reinforce requirements for banks to manage interest rate risk

The Australian Prudential Regulation Authority (APRA) has released updated requirements for banks to better manage the impact of interest rate changes on their financial position.

In a response to its November 2022 consultation released today, APRA has updated its revisions to Prudential Standard APS 117 Interest Rate Risk in the Banking book (IRRBB) aimed at:

• reducing some of the volatility in the IRRBB capital charge; 
   
• creating better incentives for banks to manage their IRRBB risk, including raising standards of governance and measurement of risk; and 
   
• simplifying and removing complexities in the IRRBB framework.

Under APS 117, banks that are classed as significant financial institutions are required to have an appropriate risk management and governance framework to manage the impact of changing interest rates on their businesses. Larger and more complex banks are also required to hold capital against this risk. 

For larger banks, APRA’s updated proposed revisions to APS 117 address previously raised concerns on the treatment of embedded gains and losses and the observation period for the capital charge methodology. These revisions are expected to reduce volatility in the IRRBB capital charge compared to the current framework.

APRA is now commencing a short consultation on some aspects of APS 117 which are also relevant to smaller banks. 

The proposals outlined in the response paper principally reaffirm that all banks are required to manage their material risks, including IRRBB, commensurate with their nature, scale, and complexity. Where APRA deems banks are not managing their interest rate risk appropriately, APRA may require them to hold additional regulatory capital under APS 117.

APRA Member Therese McCarthy Hockey said these proposals are among a range of measures APRA is taking in response to the global banking turmoil earlier this year.

“A failure to manage interest rate risk was one of the primary factors behind the collapse of several US banks this year. We also saw how the failure of one bank, even if not considered especially important systemically, can create a contagion effect that threatens other institutions within a country and across the world.

“Australia is the only country in the world that mandates provisions for interest rate risk as a core capital requirement. The new and proposed changes incorporate lessons learned from the recent large interest rate movements and overseas bank failures and will further strengthen the resilience of the banking system to potential instability. 

“Importantly, these changes should impose little financial or regulatory impost; for larger banks, we have calibrated the framework to ensure the revisions won’t result in a material increase in the IRRBB capital charge; and for smaller banks, the proposed changes principally reaffirm our expectations that all banks need to manage their material risks, including IRRBB,” Ms McCarthy Hockey said.

After a three-month consultation on the latest proposed revisions, APRA intends to finalise APS 117 by the middle of next year ahead of the updated standard coming into effect from 1 October 2025. 

APRA has also today commenced consultation on a prudential practice guide (APG 117) and reporting standards and guidance to accompany the updated prudential standard APS 117. These are available at: Revisions to the capital framework for authorised deposit-taking institutions.