Behavioural Assumptions in the Management of IRRBB

Paul Newson

Previous chapters have alluded to the fact that for many banking book products, particularly those of a retail nature, there is often no single re-pricing date or external reference rate to which both the bank and the customer are contractually bound. Consequently, to manage IRRBB, assumptions have to be made as to when and by how much each product is likely to re-price in response to a move in the general level of interest rates.

This chapter will review the major categories of asset and liabilities found on a typical bank balance sheet, and highlight for each the principal areas where assumptions have to be made and the issues – both practical and theoretical – that can arise. Current accounts, permanently insensitive savings balances and equity are, however, covered separately in Chapter 8 as their management and hedging give rise to slightly different issues.

GENERAL OBSERVATIONS

Understanding of behavioural assumptions is vital to the management of IRRBB, and is what distinguishes it from the management of interest rate risk in a wholesale or trading environment where, although the products may be much more complicated, their re-pricing date is usually totally