Interest Rate Risk in the Banking Book (2nd edition)
First published:
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Interest rate basis risk and Libor transition
Foreword
Introduction to the First Edition
Introduction to the Second Edition
An overview of banking
Relevant accounting and financial concepts
Fundamentals of interest rate risk and the banking book
Standard metrics for the identification and assessment of IRRBB
Managing and hedging IRRBB
Interest rate basis risk and Libor transition
Behavioural assumptions in the management of IRRBB
Non-dated liabilities
Other types of market risk
Reporting and the management process
IRRBB: Its links to the operating plan and stress testing
Regulatory requirements
This chapter will expand upon the topic of basis risk, which was briefly introduced in Chapter 3. Basis risk can be a significant risk for many banks, but is one that standard gap and value approaches will usually miss as, in effect, they focus solely on the date when items will re-price as opposed to how much they might re-price on that date. Two sub-types – external basis and currency basis – will be examined in turn, followed by a brief summary of the possible impacts of Libor transition.
EXTERNAL REFERENCE RATE BASIS RISK
External reference rate basis risk describes the risk arising from the fact that different items, or products, on a bank’s balance sheet, even if perfectly matched in terms of re-pricing maturity, may nevertheless still re-price by different amounts because they are linked to different external rate indexes (such as Sonia and BBR).
PANEL 6.1 EXAMPLE 1
Consider a bank that lends £100 million for five years at a variable rate always 2% higher than BBR, and funds this at Sonia. BBR and Sonia are both currently at 3%, so the bank may be reasonably considered immune from changes to the “general” level of interest rates changes, provided any change is
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