- In June 2020, Finansinspektionen (“FI”) published a proposal regarding new Pillar II methods for assessing the capital requirements for market risks outside the trading book (FI Dnr 19-4434). The proposal includes interest rate risk, credit spread risk and basis spread risk.
According to the proposal, the method for calculating the capital requirement for interest rate risk shall be based on the supervisory outlier test (“SOT”) as described in the EBA’s guidelines for IRRBB (EBA/GL/2018/02). FI allows credit institutions to model the duration of non-maturity deposits (“NMDs”) from non-financial counterparties, but with restrictions in relation to the EBA's guidelines.
In addition to the capital requirement allocated for interest rate risk from the SOT, credit institutions need to allocate additional capital for credit spread risk and basis spread risk. To calculate the capital requirement for credit spread risk and basis spread risk, two standardized methods are proposed by FI. Alternatively credit institutions are allowed to use internal Value at Risk (“VaR”) models that meet certain criteria. Our recent project experience has shown that the standardized methods proposed by FI are generally conservative and lead to high capital requirements.
Internal VaR models, based on previous project experience, will result in major easing of capital requirements – we have seen easing potential of over 50 % compared to the outcome of the standardized method. Before credit institutions can start using internal VaR models for capital allocation they need to send in extensive model documentation and a quantitative analysis of the model to FI. zeb has extensive experience in both developing internal VaR models and establish model documentation that fulfils FI’s requirements.
For credit spread risk zeb offer a first “quick and dirty” calculation free of charge that is based on your portfolio that shows an estimate on the potential capital relief using an internal VaR model compared to the standardized method. If you are interested to book a meeting to discuss the topic further or perform an initial assessment of potential capital reliefs, reach out to our expert below.
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