APRA beefs up interest rate risk rules to reduce volatility

In a pre-emptive move to avoid a US-style collapse, APRA has issued new requirements for banks to better manage the impact of interest rate changes on their financial position.

Australian Prudential Regulation Authority member Therese McCarthy Hockey.

The banking watchdog has issued new requirements for banks to better manage the impact of interest rate changes on their financial position, in another move to prevent failures such as those seen in the US banking crisis this year.

The new requirements will raise governance standards to manage interest rate risks, particularly for smaller banks, and comes after the regulator introduced tighter liquidity and capital requirements earlier this year.

“A failure to manage interest rate risk was one of the primary factors behind the collapse of several US banks this year,” Australian Prudential Regulation Authority member Therese McCarthy Hockey said.

“We also saw how the failure of one bank, even if not considered especially important systemically, can create a contagion effect that threatens other institutions within a country and across the world.”

Australia is the only country that mandates provisions for interest rate risk as a core capital requirement.

The new and proposed changes will incorporate “lessons learned from the recent large interest rate movements and overseas bank failures”, she said, further strengthening the resilience of the banking system.

The changes to its Prudential Standard APS 117 Interest Rate Risk in the Banking book requirements are aimed at reducing some of the volatility in the interest rate risk capital charge and simplifying the framework.

Banks classed as significant financial institutions must have an appropriate risk management and governance framework to manage the impact of changing interest rates on their businesses.

APRA has started a short consultation period on some aspects of the changes.

“Importantly, these changes should impose little financial or regulatory impost,” she said. “For larger banks we have calibrated the framework to ensure the revisions won’t result in a material increase in the IRRBB capital charge. For smaller banks, the proposed changes principally reaffirm our expectations that all banks need to manage their material risks, including IRRBB.”

California-based Silicon Valley Bank and other regional lenders in the US collapsed this year as a result of runs when depositors learned that losses in the value of the banks’ investments – due to rapid interest rates rises – were denting the bank’s capital.

The digital connectedness of today’s banking system meant the bank runs happened much faster than regulators and executives were expecting. Lax regulations in pockets of the US banking system were blamed for the ensuing crisis.

Last month, APRA asked banks, particularly smaller ones, to address gaps in how they managed liquidity risks. Those proposals include a requirement that all banks, not just bigger banks, value liquid assets like bonds at their market value and that they hold more government bonds.