The Commonwealth Bank of Australia (CBA) slashed its capital charge for interest rate risk in the banking book (IRRBB) almost in half over the last six months of 2018 following an overhaul of its US dollar exposures and a shortening of the term of its capital investments.
IRRBB risk-weighted assets fell A$10.5 billion ($7.5 billion) or 43% to A$13.9 billion over the six months to end-December. The capital charge, calculated as 8% of RWAs, now stands at A$1.1 billion.
The bank said the drop followed a "structural reduction in the invested term of capital", a restructuring of US dollar positions, and a fall in domestic and overseas interest rates.
The CBA projected a A$328 million hit to future earnings in the event of a 200-basis point parallel increase in the Australian yield curve, down from a A$1.6 billion estimate a year ago. A 200bp parallel decrease in the curve was projected to increase future earnings by A$368 million, down from A$1.7 billion at end-2017.
What is it?
The Australian Prudential Regulation Authority requires banks under its supervision to hold capital against IRRBB, though 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.
The CBA sets its IRRBB capital using a historical simulation value-at-risk approach, set to a one-year holding period and a 99% confidence level. The interest rate scenarios fed into the simulation are derived from a six-year observation period.
Why it matters
As can be gleaned from the results of its interest rate stress test, the CBA has girded its banking book against the earnings-sapping effects of rates volatility and won a degree of regulatory capital relief as a result. The cut to IRRBB RWAs came at a good time for the bank, too, as it more than offset operational RWA increases of A$205 million and helped drive total RWAs lower over the half.
This in turn drove its Common Equity Tier 1 capital ratio higher, to 10.8% from 10.1% at end-June 2018.
Get in touch
What can other Aussie banks learn from the CBA's efforts in tackling IRRBB? Let us know by emailing louie.woodall@infopro-digital.com, tweeting @LouieWoodall or messaging on LinkedIn. Keep up with the Quantum team by following @RiskQuantum.
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Commonwealth Bank hit by A$1bn op risk add-on
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