Principles for the Management of Interest Rate Risk
22 January 1997
The Basle Committee on Banking Supervision, with the agreement of the central bank Governors of the Group of Ten countries, is today releasing a consultative paper containing a set of Principles for the Management of Interest Rate Risk. The paper reemphasises the need for banks to maintain adequate risk management practices in all their activities and identifies specific agreed principles that supervisory authorities will consider in evaluating banks' management of interest rate risk. Comments on these proposals are invited from non-G-10 supervisory authorities, banks and other interested parties by 15th April 1997. The text of this paper can be obtained from the BIS Web Site on the Internet at http://www.bis.org with effect from 22nd January 1997, from national supervisory authorities or from the Basle Committee Secretariat at the Bank for International Settlements.
Notes for editors
The Basle Committee on Banking Supervision is a Committee of banking supervisory authorities, established by the central bank Governors of the Group of Ten countries in 1975, and chaired by Dott. T. Padoa-Schioppa, Deputy Director General of the Bank of Italy. It consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, United Kingdom and the United States. It usually meets at the Bank for International Settlements in Basle, where its permanent Secretariat is located.
In July 1988, the Basle Committee agreed on minimum standards for the capital adequacy of banks in the G-10 countries, to take full effect at end-1992. In January 1996 this framework, which principally applies to credit risk, was refined to incorporate capital charges also for market risk in banks' trading books (Amendment to the Capital Accord to incorporate market risks). Accordingly, as from end-1997, the supervisory capital requirements established by the Basle Committee will cover market risk in the trading activities of banks.
The present consultative proposal sets out twelve principles of more general application for the management of interest rate risk, independent of whether the positions are part of the trading book or reflect banks' non-trading activities. The principles emphasise that it is essential for banks to have a comprehensive risk management process in place that effectively identifies, measures, monitors and controls interest rate risk exposures, and that is subject to appropriate board and senior management oversight. The principles are:
A. The role of the board and senior management
1. In order to carry out its responsibilities, the board of directors in a bank should approve interest rate risk management policies and procedures, and should be informed regularly of the interest rate risk exposure of the bank.
2. Senior management must ensure that the structure of the bank's business and the level of interest rate risk it assumes are effectively managed, that appropriate policies and procedures are established to control and limit these risks, and that resources are available for evaluating and controlling interest rate risk.
3. Banks should have a risk management function with clearly defined duties that reports risk exposures directly to senior management and the board of directors and is sufficiently independent from the business lines of the bank. Larger or more complex banks should have units responsible for the design and administration of the bank's interest rate risk management system.
B. Policies and procedures
4. It is essential that banks' interest rate risk policies and procedures be clearly defined and consistent with the nature and complexity of their activities. These policies should address the bank's exposures on a consolidated basis and, as appropriate, also at the level of individual affiliates.
5. It is important that banks identify the risks inherent in new products and activities and ensure these are subject to adequate procedures and controls before being introduced or undertaken. Major hedging or risk management initiatives should be approved in advance by the board or its appropriate delegated committee.
C. Measurement and monitoring system
6. It is essential that banks have interest rate risk measurement systems that capture all material sources of interest rate risk and that assess the effect of interest rate changes in ways which are consistent with the scope of their activities. The assumptions underlying the system should be clearly understood by risk managers and bank management.
7. Banks must establish and enforce operating limits and other practices that maintain exposures within levels consistent with their internal policies.
8. Banks should measure their vulnerability to loss under stressful market conditions - including the breakdown of key assumptions - and consider those results when establishing and reviewing their policies and limits for interest rate risk.
9. Banks must have adequate information systems for monitoring and reporting interest rate exposures to senior management and boards of directors on a timely basis.
D. Independent controls
10. Banks must have adequate internal controls for their interest rate risk management process and should evaluate the adequacy and integrity of those controls periodically. Individuals responsible for evaluating control procedures must be independent of the function they are assigned to review.
11. Banks should periodically conduct an independent review of the adequacy and integrity of their risk management processes. Such reviews should be available to relevant supervisory authorities.
E. Information for supervisory authorities
12. The G-10 supervisory authorities will obtain from banks sufficient and timely information with which to evaluate their level of interest rate risk. This information should take appropriate account of the range of maturities and currencies in each bank's portfolio, as well as other relevant factors, such as the distinction between trading and non-trading activities. Other supervisory authorities are recommended to obtain similar information.
In developing these principles, the Committee has drawn not only on supervisory guidance in member countries but also on the comments of the banking industry on an earlier consultative paper on the measurement of banks exposure to interest rate risk, issued by the Committee in April 1993.
The principles are intended to be of general application even though their specific application will depend to some extent on the complexity and range of activities undertaken by individual banks. Supervisory authorities should, therefore, use them to re-assess their own supervisory methods and procedures for monitoring how banks control interest rate risk. The principles provide the standards to be used by national supervisory authorities in evaluating the adequacy and effectiveness of a bank's interest rate risk management.The paper also provides supervisory authorities with a basic framework for obtaining information on interest rate risk, which can then be used in a variety of ways by supervisory authorities to provide quantitative assessments of the interest rate risk faced by banks.
22nd January 1997