CA-9.1.1

This chapter describes the standardised approach for the measurement of the interest rate risk in the bank's trading book, in order to determine the capital requirement for this risk. The interest rate exposure captured includes exposure arising from interest-bearing and discounted financial instruments, derivatives which are based on the movement of interest rates, foreign exchange forwards, and interest rate exposure embedded in derivatives which are based on non-interest rate related instruments.

CA-9.1.2

For the guidance of the banks, and without being exhaustive, the following list includes financial instruments in the trading book to which interest rate risk capital requirements will apply, irrespective of whether or not the instruments carry coupons:

⁶³See Section CA-10.1 for an explanation of the circumstances in which convertible securities should be treated as equity instruments. In other circumstances, they should be treated as debt instruments.

⁶⁴Traded mortgage securities and mortgage derivative products possess unique characteristics because of the risk of pre-payment. It is possible that including such products within the standardised methodology as if they were similar to other securitised assets may not capture all the risks of holding positions in them. Banks which have traded mortgage securities and mortgage derivative products should discuss their proposed treatment with the CBB and obtain the CBB's prior written approval for it.

CA-9.1.3

A security which is the subject of a repurchase or securities lending agreement will be treated as if it were still owned by the lender of the security, i.e., it will be treated in the same manner as other securities positions.

CA-9.1.4

The minimum capital requirement is expressed in terms of two separately calculated charges, one applying to the "specific risk" of each security, whether it is a short or a long position, and the other to the interest rate risk in the portfolio (termed "general market risk") where long and short positions in different securities or instruments can be offset. The bank must, however, determine the specific risk capital charge for the correlation trading portfolio as follows: The bank computes (i) the total specific risk capital charges that would apply just to the net long positions from the net long correlation trading exposures combined, and (ii) the total specific risk capital charges that would apply just to the net short positions from the net short correlation trading exposures combined. The larger of these total amounts is then the specific risk capital charge for the correlation trading portfolio.

CA-9.1.4A

During a transitional period until 31 December 2013, the bank may exclude positions in securitisation instruments which are not included in the correlation trading portfolio from the calculation according to Paragraph CA-9.1.4 and determine the specific risk capital charge as follows: The bank computes (i) the total specific risk capital charge that would apply just to the net long positions in securitisation instruments in the trading book, and (ii) the total specific risk capital charge that would apply just to the net short positions in securitisation instruments in the trading book. The larger of these total amounts is then specific risk capital charge for the securitisation positions in the trading book. This calculation must be undertaken separately from the calculation for the correlation trading portfolio.

CA-9.1.5

The specific risk capital requirement recognises that individual instruments may change in value for reasons other than shifts in the yield curve of a given currency. The general risk capital requirement reflects the price change of these products caused by parallel and non-parallel shifts in the yield curve, as well as the difficulty of constructing perfect hedges.

CA-9.1.6

There is general market risk inherent in all interest rate risk positions. This may be accompanied by one or more out of specific interest rate risk, counterparty risk, equity risk and foreign exchange risk, depending on the nature of the position. Banks must consider carefully which risks are generated by each individual position. It should be recognised that the identification of the risks will require the application of the appropriate level of technical skills and professional judgment.

CA-9.1.7

Banks which have the intention and capability to use internal models for the measurement of general and specific interest rate risks and, hence, for the calculation of the capital requirement, should seek the prior written approval of the CBB for those models. The CBB's detailed rules for the recognition and use of internal models are included in chapter CA-14. Banks which do not use internal models should adopt the standardised approach to calculate the interest rate risk capital requirement, as set out in detail in this chapter.

CA-9.2.1

The capital charge for specific risk is designed to protect against a movement in the price of an individual instrument, owing to factors related to the individual issuer.

CA-9.2.2

In measuring the specific risk for interest rate related instruments, a bank may net, by value, long and short positions (including positions in derivatives) in the same debt instrument to generate the individual net position in that instrument. Instruments will be considered to be the same where the issuer is the same, they have an equivalent ranking in a liquidation, and the currency, the coupon and the maturity are the same.

CA-9.2.3

The specific risk capital requirement is determined by weighting the current market value of each individual net position, whether long or short, according to its allocation among the following broad categories:

CA-9.2.4

When the government paper is denominated in the domestic currency and funded by the bank in the same currency, a 0% specific risk charge may be applied.

CA-9.2.5

Central "government" debt instruments will include all forms of government paper, including bonds, treasury bills and other short-term instruments.

CA-9.2.6

The CBB reserves the right to apply a specific risk weight to securities issued by certain foreign governments, especially to securities denominated in a currency other than that of the issuing government.

CA-9.2.7

The "qualifying" category includes securities issued by or fully guaranteed by public sector entities and multilateral development banks (refer to Paragraph CA-3.2.8), plus other securities that are:

Specific Risk Rules for Unrated Debt Securities

Specific Risk Rules for Non-qualifying Issuers

Specific Risk Rules for Positions Covered under the Securitisation Framework

Specific Risk Capital Charges for Positions Hedged by Credit Derivatives

CA-9.3.1

The capital requirements for general market risk are designed to capture the risk of loss arising from changes in market interest rates, i.e. the risk of parallel and non-parallel shifts in the yield curve. A choice between two principal methods of measuring the general market risk is permitted, a "maturity" method and a "duration" method. In each method, the capital charge is the sum of the following four components:

CA-9.3.2

Separate maturity ladders should be used for each currency and capital charges should be calculated for each currency separately and then summed, by applying the prevailing foreign exchange spot rates, with no off-setting between positions of opposite sign.

CA-9.3.3

In the case of those currencies in which the value and volume of business is insignificant, separate maturity ladders for each currency are not required. Instead, the bank may construct a single maturity ladder and slot, within each appropriate time-band, the net long or short position for each currency. However, these individual net positions are to be summed within each time-band, irrespective of whether they are long or short positions, to arrive at the gross position figure for the time-band.

CA-9.3.4

A combination of the two methods (referred to under Paragraph CA-9.3.1) is not permitted. Any exceptions to this rule will require the prior written approval of the CBB. It is expected that such approval will only be given in cases where a bank clearly demonstrates to the CBB, the difficulty in applying, to a definite category of trading instruments, the method otherwise chosen by the bank as the normal method. It is further expected that the CBB may, in future years, consider recognising the duration method as the approved method, and the use of the maturity method may be discontinued.

CA-9.4.1

A worked example of the maturity method is included in Appendix CA-11. The various time-bands and their risk weights, relevant to the maturity method, are illustrated in Paragraph CA-9.4.2(a) below.

CA-9.4.2

The steps in the calculation of the general market risk for interest rate positions, under this method, are set out below:

Maturity Method: Time-bands and Risk Weights

Item (i) is referred to as the vertical disallowance, items (ii) through (iv) as the first set of horizontal disallowances, and items (v) through (vii) as the second set of horizontal disallowances.

CA-9.5.1

The duration method is an alternative approach to measuring the exposure to parallel and non-parallel shifts in the yield curve, and recognises the use of duration as an indicator of the sensitivity of individual positions to changes in market yields. Under this method, banks may use a duration-based system for determining their general interest rate risk capital requirements for traded debt instruments and other sources of interest rate exposures including derivatives. A worked example of the duration method is included in Appendix CA-12. The various time-bands and assumed changes in yield, relevant to the duration method, are illustrated below.

Duration Method: Time-bands and Assumed Changes in Yield

CA-9.5.2

Banks must notify the CBB of the circumstances in which they elect to use this method. Once chosen, the duration method must be consistently applied, in accordance with the requirements of Section CA-9.3.

CA-9.5.3

Where a bank has chosen to use the duration method, it is possible that it will not be suitable for certain instruments. In such cases, the bank must seek the advice of the CBB or obtain approval for application of the maturity method to the specific category(ies) of instruments, in accordance with the provisions of Section CA-9.3.

CA-9.5.4

The steps in the calculation of the general market risk for interest rate positions, under this method, are set out below:

(b) The bank will calculate, for each debt instrument, the modified duration (M) on the basis of the following formula:


r = YTM % per annum expressed as a decimal

C = Cash flow at time t

t = time at which cash flows occur, in years

m = time to maturity, in years

Item (i) is referred to as the vertical disallowance, items (ii) through (iv) as the first set of horizontal disallowances, and items (v) through (vii) as the second set of horizontal disallowances.

CA-9.6.1

Banks which propose to use internal models to measure the interest rate risk inherent in derivatives will seek the prior written approval of the CBB for applying those models. The use of internal models to measure market risk, and the CBB's rules applicable to them, are discussed in detail in chapter CA-14.

CA-9.6.2

Where a bank, with the prior written approval of the CBB, uses an interest rate sensitivity model, the output of that model is used, by the duration method, to calculate the general market risk as described in Section CA-9.5.

CA-9.6.3

Where a bank does not propose to use models, it must use the techniques described in the following Paragraphs, for measuring the market risk on interest rate derivatives. The measurement system should include all interest rate derivatives and off-balance-sheet instruments in the trading book which react to changes in interest rates (e.g. forward rate agreements, other forward contracts, bond futures, interest rate and cross-currency swaps, options and forward foreign exchange contracts). Where a bank has obtained the approval of the CBB for the use of non-interest rate derivatives models, the embedded interest rate exposures should be incorporated in the standardised measurement framework described in Sections CA-9.7 to CA-9.9.

CA-9.6.4

Derivative positions will attract specific risk only when they are based on an underlying instrument or security. For instance, where the underlying exposure is an interest rate exposure, as in a swap based upon inter-bank rates, there will be no specific risk, but only counterparty risk. A similar treatment applies to FRAs, forward foreign exchange contracts and interest rate futures. However, for a swap based on a bond yield, or a futures contract based on a debt security or an index representing a basket of debt securities, the credit risk of the issuer of the underlying bond will generate a specific risk capital requirement. Future cash flows derived from positions in derivatives will generate counterparty risk requirements related to the counterparty in the trade, in addition to position risk requirements (specific and general market risk) related to the underlying security.

CA-9.6.5

A summary of the rules for dealing with interest rate derivatives (other than options) is set out in Section CA-9.9. The treatment of options, being a complex issue, is dealt with in detail in chapter CA-13.

CA-9.7.1

The derivatives should be converted to positions in the relevant underlying and become subject to specific and general market risk charges as described in Sections CA-9.2 and CA-9.3, respectively. For the purpose of calculation by the standard formulae, the amounts reported are the market values of the principal amounts of the underlying or of the notional underlying. For instruments where the apparent notional amount differs from the effective notional amount, banks must use the latter.

CA-9.7.2

The remaining Paragraphs in this Section include the guidelines for the calculation of positions in different categories of interest rate derivatives. Banks which need further assistance in the calculation, particularly in relation to complex instruments, should contact the CBB in writing.

Forward Foreign Exchange Contracts

Deposit Futures and FRAs

Bond futures and Forward Bond Transactions

Swaps

Permissible Offsetting of Fully Matched Positions for Both Specific and General Market Risk

Permissible Offsetting of Closely Matched Positions for General Market Risk Only

CA-9.9.1

After calculating the derivatives positions, taking account of the permissible offsetting of matched positions, as explained in Section CA-9.8, the capital charges for specific and general market risk for interest rate derivatives are calculated in the same manner as for cash positions, as described earlier in this chapter.

Summary of Treatment of Interest Rate Derivatives