1 Introduction

On the basis of Section 25a(2) KWG, this Circular specifies the requirements which arise for institutions with regard to the application of a sudden and unexpected change in interest rates to be specified by the national supervisory authority.

Article 97 of Directive 2013/36/EU (CRD IV) requires national supervisory authorities to review and assess whether the institution's internal processes and procedures ensure sound risk management and risk coverage. According to Article 98(5) CRD IV, this review and evaluation shall also include the interest rate risk in the banking book. Accordingly, competent authorities shall take measures at least if the economic value (net present value of the banking book positions) of an institution decreases by more than 20% of its own funds in the event of a sudden and unexpected interest rate change of 200 basis points (institution with elevated interest rate risk). These measures may include a review of the capital assessment in the supervisory review and evaluation process (SREP). There is no automatic supervisory mechanism for setting the level of capital requirements if the 20% threshold is exceeded.

As part of its work to strengthen supervisory convergence in Europe, the European Banking Authority (EBA) has substantiated this directive by revising the "Guidelines on the management of interest rate risk arising from non-trading book activities" (EBA/GL/2018/02) and introduced an additional early warning indicator to identify institutions that would incur a loss of more than 15% of tier 1 capital as a result of a sudden and unexpected change in interest rates. No supervisory measures that result solely from exceeding this threshold are planned.

This Circular takes into account the framework set out in these guidelines for the completion of Article 98(5) CRD IV. In this context institutions shall calculate the effects of a sudden and unexpected change in interest rates on the basis of their internal methods and procedures for managing and monitoring interest rate risks in the banking book on their own responsibility and shall comply with the requirements in sections 3 and 4 of this Circular

2 Addressees

The requirements of this Circular are to be observed by all credit institutions within the meaning of Section 1(1) KWG that are not exempted from the application of Section 10(3) KWG, as well as by the Kreditanstalt für Wiederaufbau (KfW). Securities trading banks are excluded from this.

Insofar as credit institutions subject to the direct supervision of the ECB report the effects of the interest rate scenarios described under section 3 to the ECB on the quarterly reporting date, they may also fulfil the reporting obligation pursuant to the Financial and Internal Capital Adequacy Information Regulation (Verordnung zur Einreichung von Finanz- und Risikotragfähigkeitsinformationen – FinaRisikoV) by transmitting the data determined for the purpose of reporting to the ECB to the Deutsche Bundesbank and BaFin. If the requirements for calculating the effects reported to the ECB differ from those set out in this Circular, the provisions of this Circular relating to the method of calculation shall not apply. Data not reported to the ECB, but subject to the reporting requirements of the FinaRisikoV, must continue to be reported by these institutions to the Deutsche Bundesbank and BaFin.

The requirements apply at both individual and group level. Institutions which make use of the exemption regarding the determination and safeguarding of risk-bearing capacity, the definition of strategies, the establishment of processes for the identification, assessment, management, monitoring and communication of risks in accordance with Section 2a (1) and (2) or (5) KWG (group waiver) and which manage interest rate risk at the application level of the group waiver, must observe the requirements exclusively at this level and not at the level of the individual institution.

3 Calculation of the impact of a sudden and unexpected change in interest rates

On the basis of Article 98(5) CRD IV and the revised EBA guidelines (EBA/GL/2018/02), institutions shall calculate the eight interest rate scenarios for a sudden and unexpected change in interest rates (interest rates’ impact on the economic value of the banking book) as set out in section 3.1 taking into account a ("ad hoc") shift in the yield curve by the values specified in each case.

In determining the change in economic value, the institutions must assume a static approach, i.e. only existing business is to be taken into account, but not new business. Positions are to be taken into account in the economic value calculation in accordance with their contractual fixed interest rate (for exceptions see section 3.2 b).

3.1 Regulatory interest rate scenarios

The following interest rate scenarios shall be applied for all currencies for the purpose of calculating the standard supervisory test:

The following interest rate scenarios are to be used to calculate the early warning indicator:

The size of the interest rate shocks to be used for scenarios (c) - (h) is shown for the respective currencies in Table 1 in the Annex.

The size of interest rate shocks for currencies not listed in Table 1 shall be determined for the respective maturities in accordance with the methods set out in Annex III to the EBA guidelines. Institutions may also choose to use the shock caps of 400 basis points (parallel), 500 basis points (short) and 300 basis points (long) listed in Annex III instead of making their own calculations for the shock sizes in these or other currencies.

3.2 Specifications for calculating the loss of economic value

As a basic principle, when calculating the change in the economic value of the banking book, institutions must take into account their internal methods and procedures. The methods and procedures must meet the requirements of the "Minimum Requirements for Risk Management" (MaRisk).

a) Positions to be included
When determining the effects of a sudden and unexpected change in interest rates, all positions in the banking book that are material for this determination and that are subject to interest rate risk must be included. This includes the interest rate-sensitive on-balance sheet and off-balance sheet items. It also includes the cash flows from direct pension obligations¹, unless the interest rate risk of these positions is already taken into account by means of another risk measurement.

In the case of a non-trading book institution, all of the institution's positions affected by interest rate risk must be included.

Institutions shall include non-performing exposures (NPEs)² as general interest rate sensitive instruments, the modelling of which should reflect the level of expected cash flows and their timing, provided that the NPE ratio (NPEs relative to all loans)³ of the institution is at least 2%. In determining expected cash flows, adjustments to the value of NPEs made under internal procedures should be taken into account. Deviating approaches are only permitted if the impact of the deviating approach on the risk figure for the scenario with the highest loss can be regarded as conservative.

Institutions shall include all significant automatic and behavioural options included in banking products. These may include both market interest rate-dependent and non-market interest rate-dependent options.

Equity components which are available to the institution for an unlimited period of time must not be included in the economic value calculation of interest rate risk.

b) Positions with indefinite contractual interest rate commitments
Positions with indefinite contractual interest rate commitments must be treated in accordance with the internal methods and procedures for managing and monitoring interest rate risk. In accordance with BTR 2.3 MaRisk, appropriate assumptions shall be defined and documented. For the purposes of this Circular, the modelled average interest rate adjustment date for liabilities without fixed interest rates (non-maturity deposits) must not exceed five years (averaging is volume-weighted over all non-maturity deposits). This 5-year upper limit applies separately for each currency. Non-maturity deposits from financial institutions should not be subject to behavioural modelling.

c) Margins in cash flows
Institutions are permitted to deduct margins from cash flows, provided that this is done in accordance with the institution's internal methods and procedures for managing and hedging interest rate risk in the banking book. This must be done consistently for all business units as well as for all on-balance sheet and off-balance sheet items. If the institution deducts the margins, it must identify the risk-free interest rate of a product at the time of its inception using a transparent method.

The supervisor shall be informed whether the margins are deducted when determining the interest rate risk.

d) Foreign currency positions
If an institution has significant positions in foreign currencies, the change in economic value in each of these currencies shall be calculated in the same way as for positions in euro and converted into euro using the exchange rate prevailing at the time of observation.

A currency shall be deemed material if the interest-bearing positions denominated in that currency account for at least 5% of the interest-bearing positions on the assets or liabilities side of the banking book. If the sum of the interest-bearing positions included in the calculation is less than 90% of the interest-bearing positions on the assets or liabilities side of the banking book, currencies below the 5% threshold must also be included. In this context, the sudden and unexpected change in interest rates pursuant to section 3 refers to a change in the foreign currency interest rate.

When calculating the aggregated change in the economic value institutions shall consistently add together the negative and positive changes in the economic value of the banking book⁴ in individual currencies converted into euro for each interest rate shock scenario. Positive changes can be credited with a share of 50%.⁵

e) Interest rate floor
For each currency, a maturity-dependent interest rate floor – starting at
-100 basis points for positions with immediate maturity – shall be applied to the yield curve after the application of the interest rate shock. The lower limit increases linearly by 5 basis points per year until a floor of 0% is finally reached for maturities of 20 years and over. If the observed interest rates are below the corresponding maturity-dependent interest rate floor, institutions must use the lower observed rate as the interest rate floor.

Notwithstanding this general regulatory floor, product-specific floors above the regulatory floor must always be observed⁶.

f) Discounting
In determining the impact of interest rate changes on the economic value, institutions shall use one risk-free yield curve per currency for discounting purposes.

4 Evaluation of the interest rate scenarios

The change in the economic value of positions not included in the trading book (= net present value of the banking book positions) calculated in accordance with the requirements set out in section 3 is the basis for the analysis of the interest rate risks of the institutions by the supervisory authority pursuant to Section 25a(2) KWG.

a) Supervisory outlier test
The interest rate risk coefficient is the change in the economic value of the banking book resulting from scenarios (a) and (b) specified in section 3.1 in relation to the regulatory capital (regulatory own funds) pursuant to Article 72 of Regulation (EU) No. 575/2013 (CRR). The total regulatory own funds according to COREP reporting form C 01.00 row 010 are used as the basis. The interest rate risk coefficient with the (higher) loss of economic value is relevant for the supervisory assessment.

Institutions with an interest rate risk coefficient of more than 20% are considered as an institution with elevated interest rate risk.

(b) Early warning indicator
The early warning indicator is the change in the economic value of the banking book resulting from scenarios (c) - (h) specified in section 3.1 in relation to tier 1 capital in accordance with Article 25 CRR. The tier 1 capital as defined in COREP reporting form C 01.00 row 015 is used as a basis.
The threshold of the early warning indicator is 15%.

(c) Calculation frequency
The calculation frequency for determining the effects of a sudden and unexpected change in interest rates must be determined by each institution on its own responsibility in accordance with the requirements of BTR 2.3 MaRisk, but must take place at least quarterly.

If the institution makes significant interest rate risk increasing portfolio changes in the banking book, the ratios in accordance with section 5 of this Circular must also be recalculated.

5 Supervisory information needs

The institutions must report the following information determined at the end of each quarter (data cut-off date) both at individual institution level and at group level⁷ to BaFin and the Deutsche Bundesbank in accordance with FinaRisikoV:

• the economic value of the banking book,
• the absolute change in economic value and the coefficient from change in economic value and regulatory capital in the event of an interest rate increase of +200 basis points (scenario (a)),
• the absolute change in economic value and the coefficient from change in economic value and regulatory capital in the event of an interest rate decrease of -200 basis points (scenario (b)),
• the absolute change in economic value as well as the coefficients from change in economic value and tier 1 capital for the six interest rate scenarios (c) - (h) of the early warning indicator,
• the treatment of margin cash flows and
• whether the institution makes use of the group waiver pursuant to Section 2a(1) and (2) or (5) KWG.

The Deutsche Bundesbank has provided an appropriate notification form and details of the technical transmission.

Where necessary, the supervisory authority will obtain further information from the institutions concerned.

In addition to the reporting obligation pursuant to the FinaRisikoV, the external annual accounts auditor is obliged under Section 14(2) of the Audit Report Ordinance (Prüfungsberichtsverordnung – PrüfbV) to document “the amount of the potential loss in accordance with the specified interest rate change pursuant to Section 25a(2) sentence 1 KWG at the last calculation date” in its audit report.

Clarification:
Pursuant to Article 98(5) CRD IV, the interest rate risk coefficient is a key criterion for the supervisory review and assessment of interest rate risk in the banking book.

However, neither the 20% threshold of the supervisory standard test nor the 15% threshold of the early warning indicator is to be understood as a lower limit set by the supervisory authority for ordering supervisory measures with regard to interest rate risk in the banking book.

The supervisory authority examines the extent to which it shall order increased capital requirements for institutions pursuant to Article 104(1a) CRD IV in conjunction with Section 10(3) sentence 1 and sentence 2 no. 1 KWG for the interest rate risk in the banking book. This authorisation does not only apply to institutions with elevated interest rate risk.

6. Replacement of previous Circulars

This Circular replaces Circular 09/2018 (BA).

Röseler