Economic Capital, Accrual Book Risk and Basel II
Posted: 20 February 2008 | Source: SunGard
Most industry observers have come to believe that Basel II will not impact their methodologies or practices surrounding traditional interest rate risk (IRR) measurement. This seems a reasonableconclusion given that market risk for the accrual-book, that is the non-trading book of business, remains a Pillar II item; however, it is notable that the Basel Committee released an updated document on IRR in July of 2004 entitled “Principles for the Management and Supervision of Interest Rate Risk”.
This document replaces the September 1997 document on IRR management. Given the industry focus on the credit and operational risk pieces of the proposal, it is easy to understand why and how this IRR principles statement has been largely ignored. Nonetheless, based on actual or perceived differences in the new document’s language, there are some issues that could develop and for which Asset/Liability Management (ALM) risk personnel need to be made aware. The two issues we will discuss in this article are:
- The potential misinterpretation of the standardized rate shock methods (i.e., paragraph 81(a) and (b))
- The advancement of economic-value of equity (EVE) measures as the appropriate risk measure for purposes of capital-at-risk calculations.