Interest Rate Risk on the Banking Book

Abstract

Exposure to changes in interest rates is a fundamental feature of most banking activities, and it is inherently linked to their maturity transformation role. Interest rate risk on the banking book (IRRBB) is defined as “the current or perspective risk to the bank’s capital and earnings arising from adverse movements in the interest rates that affect the institutions banking book positions” (BCBS, 2015). A financial institution’s banking book is composed of all assets that are not actively traded and that are meant to be held until they mature, while those in the trading book are traded on the market and valued accordingly. The different regulatory and accounting treatment of the banking and trading book is considered one of the compounding factors of the 2008–09 financial crisis as banks shifted substantial assets (in particular the infamous collateralized debt obligations) from the banking to the trading book to take advantage of lower capital requirements. Consequently, national and international regulatory authorities have reviewed and modified the treatment of the trading and the banking book, with the latter, at the time of writing, still the subject of consultation, in particular on the issue of capital requirement under Pillar 1 of the Basel framework (BCBS, 2015 ibid.).