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How are IRRBB regulations effecting FTP and IRR management for products with embedded behavioral options?
The IRRBB regulations published within the last two years by EBA and BCBS very strongly underline the interest rate optionality risk embedded into banking products, as something which seems to be underestimated by banks. The interest rate risk is quite well assessed, measured and managed, to the level to which it refers to reprising period or IR options e.g. caps or floors. The behavioral optionality risk was, or in some cases still is, a risk realised by the banks, but not too much care was/is put into the proper risk management process. The key point is, the regulators leave banks a huge space for both interpretation and tackling the risk, advising at the same time about the risks related to being to much optimistic with e.g. NMD modeling and risk of overvaluing them. Neither the EBA guidelines nor BCBS standards refer directly to FTP, leaving the banks autonomy in this respect, however if banks think seriously about IRR related to embedded options, this should be reflected in FTP system, as additional component to market risk rate. This element should be treated as both risk transfer and price indicator component. Finally this kind of risk should be reported and managed, what for banks might be a huge challenge, from different perspectives. The first one relates to IT and proper optionality risk recognition, as not all BO systems data basis and finally FO systems have such product characteristics. Next issue to be tackled is the proper modeling of such risk and fulfilling all regulatory requirements referring to models’ governance. Another problem which may be visible on less developed markets refers to lack of hedging instruments to actively and in a cost efficient manner manage the risk e.g. lack of liquid swaption market in particular currencies.
How do regulators expect banks to treat deposits and loans with behavioral options and what difficulties are the banks facing while having such products on their balance sheet?
The regulators expect the banks to be risk aware and recognize that some clients behave different to what can be expected from economic perspective. This behavioral options risk refers to prepayment options embedded into loans, pipeline exposures, redemption risk of term deposits, IR modeling for non-maturity products like NMD, credit cards, overdrafts.
However the devil is in the details, which are beyond strict regulations (e.g. for NMD, BCBS regulation put cap on core value and maximum average maturity, EBA on maximum average maturity for the whole NMD balances). Depending on the bank’s risk awareness and the risk understanding, the same risk profile resulting from the same clients products’ portfolio, can be assessed in a different way, resulting in different risk profile to be managed, and thus different impact on both NII and EVE. One might wonder if that’s a correct approach. I would say, it’s always a question of finding the right balance between regulations being too strict and unified for all banks and regulations being too general, to keep the risks under control for each bank. 
For risk aware bank, regulations should be treated like guidelines, leaving the management of the bank in management’s hands.
The difficulty with optionality risk for banking book is that it’s not only product specific, but to a high extend client related. Depending on the type of client, the risk will materialise in completely different way – the financial institutions drivers to exercise the option (“pure economic perspective”) would be almost completely different to retail clients, which very rare behave like, to quote Dan Ariely, “econs”. From economic and financial markets perspective, the retail clients may behave irrational and the level of “irrationality” depends on particular client. This is made clear by BCBS regulations, when behavioral treatment of embedded options refers to retail clients only, while wholesale clients are treated as “rational” and thus behavioral options are treated automatic options like (exercised while all-in “in the money”). The role of a bank is to understand the drivers of clients’ behavior, analyse and foresee them -  the regulators expect the banks to do so in all risk management areas.  
What are in your opinion the best practices in FTP area?
The major question with regards to FTP and best practices is about the primary function FTP plays in an institution. For me FTP’s primary function is risk transfer, so looking from that perspective, FTP should properly transfer the risks embedded into products offered to the clients from business units to risk management units. Clear distinguishing and split between different components of FTP is crucial for proper risk assessment and management process. The banking world becomes more and more complicated and demanding and the pure interest rate risk and liquidity components are not sufficient any more. Next to risks visible on the first sight, there are also those like optionality risk, which in my opinion haven’t been fully recognized and understood yet. 
Moreover, new regulations in liquidity area justify adding to FTP additional components to reflect LCR and NSFR adjustments. QE forced us to think how collateral eligible assets should be remunerated. I would qualify the last two into liquidity management category, but I also saw a practice to treat them as additional FTP components, next to liquidity risk. On the top, some banks include into FTP additional components referring to capital consumption and administrative cost. For me both of them should be a part product profitability reporting system rather than pure FTP. 
Finally, for the majority of institutions balance sheet steering means using FTP for incentivizing particular products by managerial adjustments, which for me seems to be against pure FTP function, which is the risk transfer. I could support the corrections as managerial tool used for balance sheet steering, but keep it separately, next to capital charge and administrative cost, as only such approach would give you the clear picture of profitability of particular products and P&L drivers on both business lines and risk management units (ALM).
What would you like to achieve by attending the 6th Annual Funds Transfer Pricing and Balance Sheet Management conference?
Working for years in the banking area, I learned that banking is not only about finance, risk, sophisticated math and markets, but first of all about people. Banks would not exist without people, people from both perspectives, inside the bank and outside, meaning our clients, co-operators and advisors. As the market risk is relatively well understood from market perspective, there is a huge area to be explored from people perspective – understand how they think, behave, what drives them – that is crucial for understanding banking book’s risks, in particular in relation to retail clients. Attending the  6th Annual Funds Transfer Pricing and Balance Sheet Management will give me the opportunity to meet a lot of people from different countries, cultures and mentalities. This will be a great occasion to talk to them and learn how they think about different issues and what their experiences are. I would like to find out what problems they have already tackled and solutions they work on, what are their successes and lessons learned from failures.
It’s not only a great conference for networking and sharing ideas, but also for meeting “old friends” and making new friendships.  I believe, that “life” discussion with people in a very open and friendly atmosphere is much more fruitful; it’s a more effective way of gaining knowledge and broaden horizons than just reading a lot of books. For me, the conference is also a great opportunity to combine work with fun.


Ahead of the 6th Annual Funds Transfer Pricing and Balance Sheet Management, read here an interview with Mrs. Monika Bączyńska, Head of ALM at mBank about the IRRBB  regulations affecting FTP management.

Practical Insights From:
  • Mike Gregory, Global Head of FTP
    Standard Chartered Bank 
  • Edwin Luppert, Head of Internal Funds Transfer Pricing
  • Johan Von Solms, Head of FTP
  • Chris de Stigter, Head of FTP Team
    ABN Amro 
  • Polina Bardaeva, Head of Group FTP
  • Philippe Jeanne, Head of ALM
  • Ali Salekfard, Head of ALM

About the conference:

This marcus evans event will provide banks with a platform to learn from practical examples of how others are already incorporating the liquidity and capital regulations into their FTP models as well as insight into future developments. Furthermore, we will build on previous years by providing expert speakers to demonstrate how to adapt FTP methodologies to suit negative interest rates and forthcoming interest rate risk regulations as well as best practices. The 6th Annual Funds Transfer Pricing and Balance Sheet Management will take place from the 14th to 16th  September 2016 in London, United Kingdom.

Copyright © 2016 Marcus Evans. All rights reserved.

Previous Attendees Include
  • Mashreq Bank
  • Bank Leumi Isreal, Mediobanca
  • ABN Amro
  • Africa Finance Corporation
  • Lloyds
  • Ciaxa Central De Credito
  • Agricola Mutuo
  • Natixis
  • Intesa Sanpaolo
  • European Investment Bank
  • Mediobanca
  • KBC Bank
  • Investec
  • ABN Amro
  • Quantitative Risk Management
  • PricewaterhouseCoopers
  • National Bank of Kuwait 

About the speaker:

Monika Bączyńska is a Head of ALM at mBank. Monika has extensive experience in managing both interest rate risk of banking book and liquidity risk, FTP rules and hedge accounting. She is also responsible for development of funding strategy as well as planning and forecasting. Before joining ALM, Monika was a Director of Analysis and Control Bureau, responsible for controlling and risk functions for Financial Market Division. She served as an advisor in FX position transfer models and accounting schemes for structured products with embedded options. Monika participated in a number of projects related to FTP policy, capital model, liquidity risk models, stress-testing, MIS and RWA optimization. Prior to joining mBank, she served as an auditor of financial institutions with EY. Monika is a CFA charter holder and Professional Risk Manager.
Funds Transfer Pricing frameworks to account for new IRRBB and capital regulations


An interview with mBank

Monika Bączyńska,
Head of ALM at mBank

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