The Validation of NMD Behavioural Models

Marco Palumbo

Regulation sets out specific requirements with regard to behavioural assumptions, especially given their pre-eminence in the outcomes of interest rate risk in the banking book (IRRBB) measures. Common products with embedded behavioural options are:¹¹ See BCBS (2016), points 44 and 45; EBA (2018), pp 36–39.

• • fixed rate loans subject to prepayment risk;

• • fixed rate loan commitments;

• • term deposits subject to early redemption risk; and

• • non-maturity deposits (NMDs).

In particular, the BCBS standards published in April 2016 and applied since the beginning of 2018, among the many principles that the banks have to adopt to proper measure, manage and control the interest rate risk (IRR) stemming from the banking book, require guidance on the model validation of the key behavioural assumptions of all products with embedded options.

A FRAMEWORK TO VALIDATE NMD BEHAVIOURAL MODELS

With regard to the model validation of NMDs, Table 13.1 shows what should be the focus of the analysis by banks on this financial product, and also the key dimensions that influence their actual IRR profile.

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