Interest Rate Risk in the Banking Book (IRRBB)

The banking book holds loans, deposits and investments kept to maturity, not traded. When rates change, interest income and expense move at different speeds. This repricing mismatch is one source; others are changes in the shape of the yield curve, differences between the benchmark rates used, and options embedded in products, such as customers repaying loans early or withdrawing term deposits early. Banks track two views: earnings, meaning net interest income over the next year or so, and economic value, which is the present value of all future cash flows. They run standard rate shocks, such as parallel moves up and down, and scenarios of steepening or flattening curves. Supervisors review the results and can ask for extra capital under Pillar 2. Banks with long fixed-rate loans funded by short deposits feel it most, as the example below shows.

Fixed-rate mortgages make up a large part of one bank's book, funded by customer deposits that reprice within months. When central bank rates rise 3%, its deposit costs climb quickly while mortgage income stays flat. The bank's model had shown a 12% drop in net interest income under that shock. It then uses interest rate swaps to turn some fixed-rate assets into floating-rate ones.