NII forecasting model for local Baltic banks IRRBB management

Abstract

This paper contributes to the existent literature and the current discussions on regulatory changes towards bank exposure to interest rate risk in the banking book (IRRBB) aiming to provide the model on the computation of earning based gap analysis under unconditional cash flow for the European Bank Authority’s (EBA’s) category 4 banks (i. e. small non-complex domestic financial institutions). The problem, discussed in this paper, arises because the Final Standards issued by the Basel Committee on Banking Supervision do not determine the level of sophistication of the IRRBB measurement techniques. There are different explanations of consultants, some surveys, and recommendations, but no suggestions on the particular modeling towards regulation in IRRBB have been found. Another issue addressed here is the uneven capacity of creating risk assessment models of large international and small domestic financial institutions due to the difference in human resources. We first discuss recent changes of regulation on interest rates in the banking book and the background of these changes. We then develop a methodology of the model for assessment of earning-based gap analysis under unconditional cash flows for the 4th category of banks (small, local banks). In addition, the model with one of the Baltic domestic commercial bank’s simulated data is tested.