Document ID: chunk:federal_register_of_legislation:F2012L02334:body:0:p14
Version: federal_register_of_legislation:F2012L02334
Segment Type: other
Provision Reference: 
Character Range: 35506–38594

for modelling repricing and yield curve risks and optionality and basis risks should be consistent.
    21.         An ADI's internal model for basis risk must explain the historical variation of margins between product interest rates and the implied cost of funds. In addition, the requirements regarding correlation assumptions detailed in paragraph 8 of this Attachment must be met.
    22.         An ADI's internal model for optionality risk must accurately capture the unique risks associated with optionality, including the non-linear price characteristics of implicit option positions.
    23.         An ADI's internal model may require assumptions about the behaviour of its customers when measuring the capital requirement for basis and optionality risks. Some of these assumptions, including those related to prepayment rates on fixed-rate loans, will be embodied within the ADI's repricing assumptions. Additional behavioural assumptions may be required for the purpose of measuring optionality risk, such as the volatility of prepayment rates or the relationship between those rates and interest rates. The measurement of basis risk will also require assumptions to be made about the variation of the ADI's customer product rates around the implied cost of funds. These types of assumptions must be clearly documented by the ADI, including reference to the data on which the assumptions rely.

Interest rate risk in the banking book capital requirement

    24.         An ADI's IRRBB capital requirement, as determined by its internal model, must be calculated as:
       (a)          the amount estimated for repricing and yield curve risks which is the estimated 99th percentile of EV0 minus EV1 (refer to paragraph 13 of this Attachment); plus
       (b)          the amounts estimated for basis and optionality risks as detailed in paragraphs 19 to 23 of this Attachment, except where the ADI has written approval from APRA to exclude basis and/or optionality risks; less
       (c)          any amount resulting from assumed diversification benefits between repricing and yield curve risks, basis risk and optionality risk; plus
       (d)          the embedded loss (or embedded gain if this amount is negative) which is defined as the sum of the book value of all banking book items minus EV0
    subject to the capital requirement not being less than zero.
    25.         An ADI may only incorporate diversification benefit estimates if the ADI can demonstrate to APRA, using robust quantitative and qualitative analysis, that its correlation estimates are appropriate and take into account the uncertainty surrounding any such estimates (particularly in periods of stress).

Stress testing

    26.         An ADI must have in place a comprehensive and rigorous program of stress testing its internal model. Stress testing must include:
       (a)          consideration of a breakdown in the ADI's key modelling assumptions, such as its repricing assumptions; and
       (b)          scenarios based on sudden changes in the level of interest rates and changes