Interest rate risk in the banking book – is the SSM’s regulatory approach tight enough?

The current low interest rate environment is an unprecedented situation for the European banking union’s single supervisory mechanism (SSM) in that it increases interest rate risk in the banking book (IRRBB) for euro area banks. Sudden upward movements in rates threaten the economic value of bank equity, and persistently high interest rates can lead to lower bank earnings. These risks point to the need for a comprehensive supervisory approach to regulating IRRBB. Given the extraordinary circumstances and high levels of IRRBB which banks are and will be exposed to, we evaluate whether the SSM’s regulatory approach is tight enough. Specifically, we assess the adequacy of the supervisory outlier tests by performing an empirical analysis on historical interest rate changes and discussing whether the earnings perspective should be included in the supervisory outlier tests. Furthermore, we consider the minimum capital requirements for IRRBB against the background of the current low interest rates. Overall, we conclude that the current SSM’s approach on IRRBB is not tight enough. While we confirm the adequacy of the existing supervisory outlier tests, we recommend complementing them with outlier tests regarding the net interest income of banks. We further recommend implementing a standardised approach for calculating minimum capital requirements to improve banks’ resilience against IRRBB.