An Overview of Banking
Relevant Accounting and Financial Concepts
Fundamentals of Interest Rate Risk and the Banking Book
Standard Metrics for Identification and Assessment of IRRBB
Managing and Hedging IRRBB
Interest Rate Basis Risk
Behavioural Assumptions in the Management of IRRBB
Other Types of Market Risk
Reporting and the Management Process
IRRBB: Its Links to the Operating Plan and Stress Testing
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.
Three sub-types – external basis, currency basis and tenor basis – will be examined in turn; the first two are reasonably straightforward, while the last is often misunderstood and requires a thorough awareness of what drives the shape of the yield curve; if this is unclear, the reader should refer to Chapter 2.
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 differently because they are explicitly or implicitly linked to different external rate indexes – for example, Libor and BBR.
PANEL 6.1 EXAMPLE 1
Consider a bank that lends £100 million for five years at a rate always 2% higher than BBR, and funds this at one-mon