The Monitoring and Control of Interest Rate Risk (May 2007)

Summary

This is Bermuda Monetary Authority guidance setting out the standards expected of licensed banks and deposit companies for measuring, monitoring and controlling interest rate risk, as part of meeting the minimum licensing criteria under the Second Schedule to the Banks and Deposit Companies Act 1999. It followed a January 2007 consultation paper and links interest rate risk oversight to the Authority's Pillar 2 capital adequacy assessment under the forthcoming Basel 2 framework.

• Governance: The Board of Directors must approve interest rate risk policies and strategies, assign lines of authority and responsibility, receive regular detailed exposure reports, and periodically review the continuing appropriateness of policies.
• Management framework: Senior management must maintain an effective monitoring and control framework covering reporting arrangements, risk limits, adequately skilled staff, separation of duties, and controls over new products before launch.
• Measurement systems: Institutions must have measurement systems capturing re-pricing, yield curve, basis and optionality risk across trading and non-trading activities, typically including gap analysis and, where relevant, currency-specific measurement.
• Limits and stress testing: Institutions must set Board-approved aggregate and, where appropriate, sub-limits on interest rate risk, and conduct stress testing covering rate shifts, yield curve changes, liquidity conditions and worst-case scenarios.
• Reporting to the Authority: Institutions must provide the Authority with regular reports on interest rate exposure in the banking book, usually quarterly, and discuss the impact of a standardized interest rate shock (a 200 basis point parallel shift or 1st/99th percentile historical rate change) on economic value.
• Public disclosure: Institutions are expected to publicly disclose information on their level of interest rate risk and their risk management policies.
• Internal system criteria (Appendix 1): Internal measurement systems must capture all material interest rate positions, use both earnings and economic value approaches (with economic value used for supervisory monitoring), have well-specified data inputs and documented assumptions, be integrated into daily risk management, and incorporate the standardized interest rate shock.

The guidance does not prescribe a standard reporting template; instead the Authority agrees reporting content bilaterally with each institution based on the nature and scale of its business.

Key obligations

• Licensed institutions must develop, implement and regularly review arrangements for measuring, monitoring and controlling interest rate risk appropriate to their business.
• The Board of Directors (or a Board committee) must approve interest rate risk policies, strategies and an aggregate risk limit, and review these periodically.
• Senior management must maintain an effective monitoring and control framework, including reporting arrangements, risk limits, adequate staffing and separation of duties.
• Institutions must maintain interest rate risk measurement systems covering re-pricing, yield curve, basis and optionality risk across trading and non-trading activities, reviewed and validated regularly.
• Institutions must set and enforce interest rate risk limits, including an aggregate Board-approved limit, with a policy for handling exceptions.
• Institutions must conduct stress testing of interest rate risk, including worst-case scenarios.
• Institutions must provide the Authority with regular reports on internal measurement systems and interest rate exposures in the banking book, usually on a quarterly basis, as agreed bilaterally with the Authority.
• Institutions must assess and discuss with the Authority the impact of a standardized interest rate shock (200 basis point parallel yield curve shift, or 1st/99th percentile historical change) on economic value, with separate currency calculations where 5% or more of banking book assets or liabilities are in another currency (subject to a stable-peg exception).
• Internal measurement systems must meet the six criteria in Appendix 1, including capturing all material interest rate positions, measuring both earnings and economic value impacts, properly specified data inputs, documented assumptions, integration into daily risk management, and incorporation of the standardized rate shock.
• Institutions are expected to publicly disclose information on their level of interest rate risk and their risk management policies.

Applies to

licensed institutions (banks and deposit companies)