RBI/2010-11/263
DBOD. No. BP. BC. 59 / 21.04.098/ 2010-11
November 4, 2010
The Chairman and Managing Directors/
Chief Executive Officers of
All Scheduled Commercial Banks
(Excluding RRBs and LABs)
Guidelines on Banks’ Asset Liability Management Framework – Interest Rate Risk
Please refer to paragraph 155 of Second Quarter Review of Monetary Policy
2009-10 announced on October 27, 2009 on introduction of Duration Gap Analysis
for interest rate risk management. Accordingly, Guidelines on Banks’ Asset
Liability Management Framework- Interest Rate Risk are furnished in Annex .
- As banks are aware, interest rate risk is the risk where changes in market
interest rates affect a bank’s financial position. Changes in interest rates
impact a bank’s earnings (i.e. reported profits) through changes in its Net
Interest Income (NII). Changes in interest rates also impact a bank’s Market
Value of Equity (MVE) (hereinafter ‘equity’ would mean ‘networth’ unless
indicated otherwise) through changes in the economic value of its interest rate
sensitive assets, liabilities and off-balance sheet positions. The interest rate
risk, when viewed from these two perspectives, is known as ‘earnings
perspective’ and ‘economic value perspective’, respectively. The earlier
guidelines (DBOD. BP. BC. 8 / 21.04.098/ 99 dated February 10, 1999) to banks
indicated approach to interest rate risk measurement from the ‘earnings
perspective’ using the Traditional Gap Analysis (TGA). To begin with, the TGA
was considered as a suitable method to measure Interest Rate Risk. Reserve Bank
had also indicated then its intention to move over to modern techniques of
Interest Rate Risk measurement like Duration Gap Analysis (DGA), Simulation and
Value at Risk over a period of time, when banks acquire sufficient expertise and
sophistication in acquiring and handling MIS.
- In this context, it is clarified that Duration Gap Analysis (DGA) is aimed at
providing an indication of the interest rate risk to which the bank is exposed.
Accordingly, the estimated drop in MVE as a result of the prescribed shock
applied would indicate the economic impact on the banks’ equity should the shock
scenario materialise but would not be an accounting loss as banking book is not
marked to market.
- The revised guidelines furnished in Annex will be effective from April 1,
2011. However, banks are advised to start full-fledged test runs on these
guidelines with effect from January 1, 2011 with a view to enable them to gain
more experience in the operation of the revised framework.
- The salient features of the guidelines furnished in the Annex are
- Banks shall adopt the DGA for interest rate risk management in addition to
the TGA followed presently.
- The framework, both DGA and TGA, should be applied to the global position of
assets, liabilities and off-balance sheet items of the bank, which are rate
sensitive. Banks should compute their interest rate risk position in each
currency applying the DGA and TGA to the rate sensitive assets/ liabilities/ off
balance sheet items in that currency, where either the assets, or liabilities
are 5 per cent or more of the total of either the bank’s global assets or global
liabilities. The interest rate risk position in all other residual currencies
should be computed separately on an aggregate basis.
- Keeping in view the level of computerisation and the current MIS in banks,
adoption of a uniform ALM System for all banks may not be feasible. The proposed
guidelines have been formulated to serve as a benchmark for banks. Banks which
have already adopted more sophisticated systems may continue their existing
systems but should also adopt the DGA and TGA as supervisory reporting/
disclosure frameworks.
- Banks should adopt the modified duration gap approach while applying the DGA
to measure interest rate risk in their balance sheets from the economic value
perspective. In view of the evolving state of computerisation and MIS in banks,
a simplified framework has been suggested, which allows banks to :
- 1.
group rate sensitive assets, liabilities and off balance sheet items under the
broad categories indicated in Appendix I under various time buckets; and
- b) compute Modified Duration (MD) of these categories of assets/ liabilities and
off-balance sheet items using the suggested common maturity, coupon and yield
parameters.
- Measurement of interest rate risk with the above method is an approximation.
Hence banks which have the capability to compute the weighted average MD of
their assets and liabilities based on the MD of each item of Rate Sensitive
Asset (RSA) / Rate Sensitive Liability (RSL) may do so.
- Each bank should set appropriate internal limits for interest rate risk
based on its risk bearing and risk management capacity, with prior approval of
its Board / Risk Management Committee of the Board.
- Banks should compute the potential decrease in earnings and fall in MVE
under various interest rate scenarios.
- In addition to extant frequency of supervisory reporting of interest rate
sensitivity as per Traditional Gap Analysis (TGA), banks shall submit a report
on interest rate sensitivity as per DGA in the stipulated format with effect
from June 30, 2011 on a quarterly basis till March 31, 2012 and monthly with
effect from April 30, 2012.
- It is clarified that the framework prescribed in this circular is aimed at
determining the impact on the MVE of the bank arising from changes in the value
of interest rate sensitive positions across the whole bank i.e. both in the
banking and trading books. This requirement is in addition to the existing
guidelines for assessing capital adequacy requirement for interest rate
sensitive positions in the trading book and banking book (under Pillar II)
separately. For the purpose of capital adequacy trading and banking books are
treated separately because generally no offset of positions between the banking
book and trading book is considered due to different accounting/valuation norms.
- After gaining significant experience with the methodology laid down in the
circular, banks may consider switching over to this methodology for management
of interest rate risk in the banking book under Pillar II.
- As per extant guidelines on management of interest rate risk in the banking
book under Pillar II, banks where the economic value of the banking book
declines by more than 20% of the MVE as a result of a standardised interest rate
shock of 200 basis points are considered outlier from supervisory perspective.
However, no such calibration is envisaged at this stage for decline in the MVE
based on the impact of the standardised interest rate shock of 200 basis points
on the entire balance sheet, under the guidelines on banks’ ALM contained in
this circular.
- Please acknowledge receipt.
Yours faithfully,
(B. Mahapatra)
Chief General Manager-in-Charge
Encls : as above