How Provisions Affect Non-Performing Exposures in IRRBB

Summary

The document compares guidance on how banks should represent non-performing exposures (NPEs) in interest rate risk in the banking book. EBA guidance says to treat exposures net of provisions as interest-sensitive instruments, using expected cash flows and their timing. The Basel Committee standards mention loan loss provisions only in a footnote, noting that accounting values may differ from balances used for IRRBB management.

The text raises questions about why EBA applies this treatment to both net interest income (NII) and economic value of equity (EVE), and why one jurisdiction reportedly nets provisions for NII but not EVE. It does not answer those questions or present analysis supporting either treatment. Its value is identifying a regulatory and modeling ambiguity for further research; it provides no jurisdiction-specific details or empirical evidence.

Key ideas

• EBA guidance treats non-performing exposures net of provisions as interest-sensitive instruments.
• Basel standards mention loan loss provisions but do not explicitly specify their IRRBB treatment.
• The document asks why provision netting may differ between NII and EVE calculations.
• The questions remain open, with no supporting analysis or jurisdiction-specific explanation.

Tags

# Non-performing exposures in IRRBB


# Non-performing exposures in IRRBB












The EBA's guidelines for IRBBB state the following in Section 4.3 regarding the impairment of bank assets:

> Institutions should consider non-performing exposures (net of provisions) as interest rate sensitive instruments reflecting expected cash flows and their timing.

However, the BCBS standards for IRRBB don't explicitly address the treatment of credit provisions. Loan loss provisions are briefly mentioned in a footnote in Annex 1:

> However, the accounting value may not be the same as the balance that needs to be managed for IRRBB purposes, because of the impact of effective interest rate calculations and the treatment of loan loss provisions.

Paul Newson's excellent book, Interest Rate Risk in the Banking Book, highlights this discrepancy:

> Non-performing exposures (NPEs) must be modelled net of any provision. BCBS 368 made no reference at all to these.

Questions:

- What's the reasoning behind EBA's decision to include NPEs net of provisions in the computation of NII and EVE?

- I'm aware of one jurisdiction where NPEs are netted of provisions for NII calculations, but not for EVE. What is the reasoning behind this approach?

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.