Aussie banks crush IRRBB capital charges

Model upgrades and exposure-reducing efforts wiped millions of dollars off the ‘Big Four’ Australian banks’ capital requirement for interest rate risk in the banking book (IRRBB) in the year to end-March.

The Commonwealth Bank of Australia achieved the greatest savings of the four, reducing IRRBB risk-weighted assets (RWA) to A$11.7 billion ($8.1 billion) from A$25.3 billion in the year-ago quarter – a reduction of 54%. Quarter-on-quarter, the RWA cut was 16%. Its IRRBB capital charge, calculated as 8% of RWA, is now A$933 million.

The lender said the quarter-on-quarter reduction was driven by model enhancements, interest rate risk management activity and higher embedded gains due to lower domestic and offshore interest rates.

Westpac blitzed IRRBB RWA by 45% to A$7.1 billion year-on-year. Lower interest rate risk exposure and an increase in embedded gains were credited with the last three months’ worth of savings.

National Australia Bank cut IRRBB RWA by 22% to A$7.7 billion year-on-year, while ANZ Bank reduced it by 20% to A$7.2 billion. ANZ cited lower exposure to yield-curve risk and repricing as drivers of its reduced IRRBB charge. NAB did not provide any commentary.  

What is it?

The Australian Prudential Regulation Authority (APRA) requires banks under its supervision to hold capital against IRRBB, although this isn't prescribed by the Basel Committee's capital framework.

The charge is intended to cover the risk of a bank’s net interest income getting pummelled by changes in interest rates. Australian banks use their internal models to determine the sensitivity of the net present value of future earnings to changes in the overall level and shape of the yield curve.

Why it matters

IRRBB capital savings have helped to offset RWA increases for other risk types at the ‘Big Four’ in recent years. Since Q1 2018, aggregate operational RWA has surged 19% to A$176.4 billion as compliance failings, unearthed by a Royal Commission inquiry, have flowed through into capital models. Big savings on the IRRBB component contained the overall RWA increase over the period to just 1%, however.

Banks have a degree of autonomy over the setting of their IRRBB charges through their internal models. As these have been refined and updated, the capital numbers they’ve generated have tended to fall. 

But a model ban may be on the cards. In a speech in October 2018, APRA executive Sean Carmody said the regulator was moving to restrict the use of internal models and inaugurate a more standardised capital charge for interest rate risk instead. This may cause IRRBB charges to climb, sapping banks’ regulatory capital ratios. 

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What’s driving APRA’s thinking on IRRBB? Help us to understand by emailing [email protected], sending a tweet to @LouieWoodall or messaging on LinkedIn.

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