Interest rate risk on the commercial transactions of Retail banking, the specialised financing subsidiaries, the savings management business lines in the Investment Solutions divi-sion and CIB’s Corporate Banking units are managed centrally by ALM & Treasury through the client intermediation book.
Interest rate risk on the Bank’s equity and investments is also managed by ALM & Treasury, in the equity intermediation and investments book.
Transactions initiated by each BNP Paribas Fortis business line are transferred to ALM & Treasury via internal contracts booked in the management accounts or via loans and borrow-ings. ALM & Treasury is responsible for managing the interest rate risk inherent in these transactions.
The main decisions concerning positions arising from banking intermediation activities are taken at monthly or quarterly committee meetings. These meetings are attended by the management of the business line, ALM & Treasury, Finance and the Risk department.
The four main sources of interest rate risk are:
Repricing risk, due to a mismatch of interest rate repricing between assets and liabilities (usual mismatch)
Changes in the structure of yield curves (parallel, flattening or steepening shifts)
Basis risk resulting from imperfect correlation between different reference rates (for example swap rates and government bond yields)
Optionality: on the asset side, certain financial instru-ments carry embedded options (hidden or explicit) that will be exercised depending on movements in interest rates.
Measurement of interest rate risk
BNP Paribas Fortis measures, monitors and controls its banking book interest rate risk using the following indicators:
Duration of equity
Interest rate sensitivity of the fair value of equity
Earnings at Risk (EaR).
duration of equity - Duration is a measure of the average timing of cash flows from an asset or a liability portfolio.
Duration of equity is an application of duration analysis and measures BNP Paribas Fortis’ consolidated interest rate sen-sitivity. It is measured as the difference between the present value of the future weighted cash flows generated by the assets and the present value of the future weighted cash flows from the liabilities. The duration of equity is an overall indica-tor of the mismatch in duration of assets and liabilities. BNP Paribas Fortis has a positive duration of equity. This means that an increase in interest rates leads to a decrease in value for the bank.
interest rate sensitivity of the fair value of equity - This approach consists of applying +/- 100bp and +/- 200bp to the fair value of an instrument or portfolio.
earnings at risk - In the case of Retail Banking activities, structural interest rate risk is also measured on a going-concern basis, through an earnings sensitivity indicator. Due to the existence of partial or even zero correlations between customer interest rates and market rates, and the volume sensitivity caused by behavioural options, rotation of balance sheet items generates a structural sensitivity of revenues to interest rate changes. Lastly, for products with underlying behavioural options, a specific option risk indicator is analysed in order to fine-tune hedging strategies.
The choice of indicators and risk modelling and the production of indicators are subject to control by independent Product Control teams and dedicated Risk teams. The results of these controls are presented regularly to specialist committees and once a year to the Board of Directors.
These indicators are systematically presented to the ALM com-mittees, and serve as the basis for hedging decisions taking into account the nature of the risk involved.
risk limits
For the customer banking intermediation books, overall interest rate risk for Retail Banking entities is subject to a primary limit, based on the sensitivity of revenues to changes in interest rates over the next 12 months. The limit is based on recurring revenues, in order to control uncertainty about future fluctuations in revenues caused by changes in interest rates.
The specialised financing subsidiaries are exposed to very low levels of interest rate risk, considering the centralisation of risks at ALM & Treasury level. The residual risk is controlled by technical interest rate gap limits, which are monitored by the ALM committee of the relevant business line.
sensitivity of the value of banking books
Since the books of financial instruments resulting from banking activities are not intended to be sold, they are not managed on the basis of their fair value.
The sensitivity analysis takes into account all future cash flows generated by transactions outstanding at the reporting date, irrespective of maturity. The sensitivity data take account of the replication portfolios and models used to generate theo-retical maturities, especially on the Bank’s equity.
The sensitivity of the value of banking intermediation books to an instantaneous change of one basis point in interest rates was an increase in value in the event of a fall and a decrease in value in the event of a rise of approximately EUR 10.6 million at 31 December 2012, compared with EUR 12.8 million at 31 December 2011.
interest rate sensitivity of the value of the banking books
31 December 2012
Less than 3 to 1 to 3 3 to More than
In thousands of euros 3 months 12 months years 5 years 5 years TOTAL
EUR 82 (187) (293) 1,892 (11,388) (9,894)
USD 13 (4) (143) (113) (42) (289)
GBP 1 6 (1) (1) 5
Other currencies 5 10 (30) (306) (144) (465)
TOTAL 101 (181) (460) 1,472 (11,575) (10,643)
31 December 2011
Less than 3 to 1 to 3 3 to More than
In thousands of euros 3 months 12 months years 5 years 5 years TOTAL
EUR 71 (883) 637 1,335 (12,907) (11,747)
USD (4) (30) (89) (482) (24) (629)
GBP (2) (21) (15) (2) (1) (41)
Other currencies 4 (12) (57) (97) (260) (422)
TOTAL 69 (946) 476 754 (13,192) (12,839)
Hedging of interest rate and currency risks
Hedging relationships initiated by the Bank mainly consist of interest rate or currency hedges in the form of swaps, options, forwards or futures.
investments in foreign operations. Each hedging relationship is formally documented at inception. The documentation describes the hedging strategy, identifies the hedged item
Global Interest rate risk
The Bank’s strategy for managing global interest rate risk is based on closely monitoring the sensitivity of the Bank’s earn-ings to changes in interest rates. In this way, it can determine how to achieve an optimum level of offset between different risks. This procedure requires an extremely accurate assess-ment of the risks incurred so that the Bank can determine the most appropriate hedging strategy, after taking into account the effects of netting the different types of risk.
These hedging strategies are defined and implemented for each portfolio and currency.
The evolution of the customer assets and liabilities (excluding reverse repos and repos) remained stable between December 2011 and the end of 2012. Due to the different production pace in liabilities versus assets the structural interest rate hedges put in place by the Bank in 2012 are based mainly on a fixed-rate lender strategy. They include derivatives accounted for as fair value hedges and government securities which are recorded in the ‘Available for sale’ category.
Interest rate risk is mitigated using a range of different instru-ments, the most important of which are derivatives - primarily interest rate swaps and options. Interest rate swaps are used to change the linear risk profile mainly caused by long-term assets and liabilities. Options are used to reduce the non-linear risk, which is mainly caused by embedded options sold to clients, e.g. caps and prepayment options on mortgages.
Structural currency risk
Currency hedges are contracted by the ALM department in respect of the Bank’s investments in foreign currencies and its future foreign currency revenues. Each hedging relation-ship is formally documented at inception. The documentation describes the hedging strategy, identifies the hedged item and the hedging instrument, and the nature of the hedged risk and describes the methodology used to test the expected (prospec-tive) and actual (retrospec(prospec-tive) effectiveness of the hedge.
A hedging relationship is applied and documented for invest-ments financed by foreign currency loans so that impacts of movements in exchange rates can be recorded in a symmetri-cal fashion and have no impact on the profit and loss account.
These instruments are designated as net investment hedges.
A similar hedging relationship is set up to hedge the cur-rency risk on net foreign curcur-rency assets of branches and consolidated subsidiaries. Fair value hedges are used to hedge the currency risk on equity investments in non-consolidated companies. No hedging relationship was disqualified from hedge accounting in 2012.
Hedging of financial instruments recognised in the balance sheet (fair value hedges)
Fair value hedges of interest rate risks relate either to specified fixed-rate assets or liabilities, or to portfolios of fixed-rate assets or liabilities. Derivatives are contracted to reduce the exposure of the fair value of these assets or liabilities to changes in interest rates. Identified assets consist mainly of available-for-sale securities. Hedges of portfolios of financial assets and liabilities relate to rate mortgages, fixed-rated debt issues demand deposits and loans.
To identify the hedged amount, the residual balance of the hedged item is split into maturity bands, and a separate amount is designated for each band. The maturity split is determined on the basis of the contractual terms of the trans-actions and historical observations of customer behaviour (prepayment assumptions and estimated default rates). No hedging relationship was disqualified from hedge accounting in 2012.
For each hedging relationship, expected hedge effectiveness is measured - prospectively and retrospectively - by ensur-ing that, for each maturity band, the balance of the hedgensur-ing instruments is not higher than that of the hedged items, which means that there is no over-hedging.
Cash Flow Hedge
In terms of interest rate risk, the Bank uses derivative instru-ments to hedge fluctuations in income and expenses arising on floating-rate assets and liabilities. Highly probable forecast transactions are also hedged. Hedged items are split into maturity bands. After taken into account prepayment assump-tions, the Bank uses derivatives to hedge some or all of the risk exposure generated by these floating-rate assets or liabilities.
Identified assets consist mainly of available-for-sale securities.
Hedges of portfolios of financial assets and liabilities relate to Bank loans and deposits, term deposits and future loans.
In the year ended 31 December 2012, no hedges of forecast transactions were re-qualified as ineligible for hedge account-ing on the grounds that the related future event was no longer highly probable.