In today’s market environment, managing interest rate risk in the banking book (IRRBB) is critical. Interest rates are at generationally high levels, and market volatility has created a high level of uncertainty about the future. The regulatory landscape has also been rapidly evolving, making compliance with guidelines increasingly challenging and costly. Effectively managing IRRBB can significantly improve a bank’s long-term financial health and regulatory standing.

The first step to mastering IRRBB is to develop a comprehensive and robust data governance framework.

"Ultimately, good data drives effective regulatory reporting and firms need the right tools and resources to achieve this. In turn, this will reduce the effort and resources required to meet their regulatory reporting needs. If they can't achieve this then they face increased costs, potential fines, and a process that hinders rather than smooths their regulatory reporting."¹ -Struan Lloyd, Head of Cappitech at S&P Global Market Intelligence

Banks need strong data governance to ensure reliable, high-quality data from all systems, which can be challenging given the multitude of systems in a typical bank's technical infrastructure. Governance involves collecting data, performing quality checks, maintaining data lineage, and managing risks like data breaches and privacy concerns. It promotes data consistency and transparency, which empowers teams across the bank, including treasury and senior management, building enterprise-wide confidence in their data health. Incomplete or inaccurate data can lead to incorrect risk assessments and decision-making and can ultimately have costly regulatory consequences.

This article sheds light on the importance of data governance in fostering a bank’s financial stability and profitability in the face of interest rate uncertainties.

IRRBB explained

The evolution of interest rate risk management in banking has been shaped by significant financial events and regulatory developments. In the 1970s, a decade marked by significant global change, multiple liquidity events underscored the necessity for improved foreign exchange and settlement risk management. In response to the growing need for better capital and liquidity risk control, the Group of Ten (G10) countries formed the Basel Committee to enhance global banking supervision. Over time, various governing bodies, such as the European Banking Authority (EBA), the Reserve Bank of India (RBI), and the US Federal Reserve, have established and published standards around capital and liquidity risk management. These guidelines include IRRBB and CSRBB.

Learn more about the evolution of IRRBB

The current principles for banks to manage IRRBB provide transparency and accountability for their management strategies, methodologies, and outcomes. Requirements include describing IRRBB mitigation strategies, detailing significant stress test analyses, and commenting on changes in metrics such as economic value of equity (EVE) and net interest income (NII). Achieving a comprehensive view of IRRBB requires the collection of large volumes of highly-granular data from multiple sources. This process can be highly time-consuming depending on the number of data sources, the extensiveness of the data catalog, and the quality of the reconciliation. If data quality issues go unnoticed, the consequences can be severe, leading to regulatory fines and undermining the bank's credibility.

Why IRRBB matters

The implementation of frameworks like IRRBB and CSRBB (credit spread risk in the banking book) has profoundly influenced balance sheet optimization in banks. The enhanced transparency into capital and liquidity risk allows banks to identify the most efficient uses of capital, lower funding costs, and verify they have adequate capital to absorb potential losses.

Regulators are also increasingly concerned with how well banks manage their interest rate risks, making it a critical component of their overall risk management strategy. Current market volatility provides a compelling reason to revisit risk frameworks, and the recent bank failures have only exacerbated this necessity.

Bank failures in the last two years²

First Republic Bank

Assets: $229.1 billion
Date of Failure: May 2023
Notable for being the second-largest bank failure in U.S. history.

Silicon Valley Bank (SVB)

Assets: $209 billion
Date of Failure: March 2023
Known for its rapid collapse, significantly impacting the tech and startup sectors.

Signature Bank

Assets: $110.4 billion
Date of Failure: March 2023
Its failure occurred shortly after SVB's, driven by a loss of depositor confidence.

Republic First Bank

Assets: $6 billion
Date of Failure: April 2024
The first bank failure of 2024, reflecting ongoing vulnerabilities in the banking sector.

Regulatory bodies require banks to maintain adequate capital and have effective risk management practices in place. Banks are then well-equipped to manage the complexities and uncertainties of financial markets, and protect their financial health and the trust of their stakeholders. Failure to do so can result in penalties, increased regulatory scrutiny, and reputational damage, not to mention the societal impact of layoffs and such in more extreme cases.

The master key that is integrated data management

Integrated data management incorporates concepts of data centralization, data democratization, and data stewardship.

Centralizing data sources across systems and depots provides a consistent and reliable access point across the bank, crucial for handling the complexities of regulatory reporting and risk management. This integration of financial risk and regulatory metrics allows banks to identify optimal uses of capital, maintain transparency, and stay compliant with evolving regulations. Modernized data platforms provide this centralization layer wrapped with robust governance structures to ensure the data is reliable.

The philosophy behind integrated data management emphasizes robust data governance frameworks that include detailed permissions, access controls, and continuous oversight. Specialized systems and point solutions typically contain their own validations, and centralizing data without duplicating quality assurance (QA) efforts can be challenging. However, the data cannot simply all be ported over into a central location due to data privacy and data localization laws.

Data mesh enables full control

The solution to this is a flexible data mesh architecture, which combines the most effective elements of each end of the spectrum. This is ideally built around a data platform that contains domain-aware QA tools which are essential for maintaining data accuracy, completeness, and timeliness. The data mesh then gives users access to data from specific domains, while data and technology teams maintain full control over the quality of the data.

To make sure this data democratization is effective, end-users need to be able to navigate to the information in a self-service manner. Rather than requiring technical writers to create process documentation for clicking around each use case, data cataloging and lineage assist in the identification of data's source, its transformation, and its use throughout the organization. This transparency not only enables better access to the data for those who require it, but it also bolsters confidence in its reliability. When data is both accessible and trusted, teams are willing to collaborate more effectively. User-centric data platforms often help scale this process by autogenerating data documentation and providing an intuitive UI to navigate data lineage.

Data governance and IRRBB

Data governance establishes data lineage and traceability to promote transparency and accountability in IRRBB analysis. Considerations around governance include QA, access controls, and distribution policies. Given the complexity of IRRBB, only data infrastructures that were purpose-built for capital markets will be able to scale properly robust governance structures. Supervisors have a crucial role in monitoring and assessing banks' IRRBB exposures, identifying any outlier banks, and evaluating the adequacy and effectiveness of their IRRBB management framework. They will require access to the data lineage, QA tools, and a detailed data catalog to assist with this assessment and ensure compliance with supervisory expectations. With a thorough, ideally bi-temporal, history of the origin and transformation of data, supervisors can efficiently validate the accuracy of their risk assessments.

This transparency is essential for meeting capital requirements and demonstrating effective risk management to regulators. Failing to do so can result in penalties and reputational damage, which is why a robust data governance framework is so important.

Going beyond compliance and risk management

Effective data governance extends beyond compliance and risk management. It enables the seamless integration of data from various sources, allowing banks to use advanced analytics and predictive models to anticipate and mitigate interest rate risks. These robust frameworks, when powered with reliable data, provide a holistic view of data across internal depots, external sources, and market data vendors. Data at a deep granularity with an extensive audit trail can enable meticulous back-testing and hyper-tailored stress scenarios. This level of transparency allows banks to proactively identify potential interest-rate-impacting events and mitigate their risk, resulting in long-term financial stability and profitability.

Data governance is not just about managing data; it is about transforming data into a strategic asset that drives informed decision-making and competitive advantage.

Mastering IRRBB

Mastering IRRBB is a strategic necessity to maintaining a bank’s financial stability and long-term viability. The enhanced transparency into capital and liquidity risk allows banks to identify the most efficient uses of capital, lower funding costs, and verify they have adequate capital to absorb potential losses. This is particularly important in the current market environment, where rising interest rates, inflationary pressures, and growing regulatory scrutiny are forcing banks to adapt their risk management frameworks.

The three components to mastering IRRBB include: robust data governance framework, advanced technology, and ongoing auditing of data governance policies.

Robust data governance framework

IRRBB requires a multi-faceted approach that places a strong emphasis on data governance. Banks must establish a robust data governance framework so that the data used for IRRBB calculations is accurate, consistent, and complete. This framework should include clear policies and procedures for data collection, validation, and storage, confirming that all relevant data is readily accessible and reliable. By implementing efficient data management practices, banks can streamline the process of gathering, storing, and retrieving the data necessary for IRRBB assessments, thereby enhancing the overall effectiveness of risk management strategies.

Advanced technology

The utilization of advanced technology is a further vital component in the management of IRRBB. Automation of data processes can significantly improve the efficiency and accuracy of IRRBB calculations. This includes the use of advanced software solutions to monitor interest rate movements, analyze risk exposure and produce comprehensive reports. Automation not only reduces the potential for human error but also allows for real-time data analysis, enabling banks to make more informed and timely decisions. Moreover, the use of advanced analytics can provide deeper insights into risk patterns and trends, helping banks to proactively manage their interest rate risk and meet stringent capital requirements.

Ongoing auditing of data governance policies

Regular review and update of data governance policies align banks with changing regulatory requirements and evolving industry best practices. The regulatory landscape is dynamic, and banks must be nimble in their approach to data governance to maintain compliance. This includes keeping up with new regulations, updating data management practices as necessary, and conducting regular audits to identify and remediate any gaps in the data governance framework. By taking a proactive approach, banks can better manage the complexities of IRRBB and achieve long-term financial soundness.

Lastly, organizations must cultivate a culture that is both risk-aware and data-driven. This involves the training and support of employees responsible for data governance and IRRBB calculations. Employees should understand the importance of accurate data management and the implications of interest rate risk on the bank's financial health. By providing ongoing education and resources, banks can empower their staff to effectively manage IRRBB and contribute to the overall success of the organization. A well-trained workforce, combined with a robust data governance framework, is the cornerstone of mastering IRRBB and fortifying the bank's resilience in the face of interest rate fluctuations.

A robust data governance framework is the cornerstone to mastering IRRBB.

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Ted O’Connor