4.6 Market Risk in the Trading Environment
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Chairman's
Foreword
Corporate
Management Report Appendices Governance
Consolidated Financial Company Financial
Statements Statements
banking book are adversely affected by changes in market
interest rates.
Interest rate risk at Rabobank arises because of repricing and
maturity mismatches between loans and funding, and optionality
in client products. Customer behavior is an important
determining factor with respect to interest rate risk in the banking
environment. The modelling of customer behavior is therefore
one of the core elements of the interest rate riskframework. There
are behavioral models in place for mortgage prepayments,
savings accounts and current accounts. Movements in interest
rates may also affect the creditworthiness of customers. Higher
interest rates might for example lead to higher borrowing costs
and, hence, have a negative impact on the creditworthiness of a
customer. Any such effects are however regarded as credit risk
rather than interest rate risk.
Rabobank accepts a certain amount of interest rate risk in the
banking environment; this is a fundamental part of banking. But
at the same time the bank also aims to avoid unexpected
material fluctuations in the financial result and the economic
value because of interest rate fluctuations. The Managing Board,
overseen by the Supervisory Board, therefore annually approves
the interest rate risk appetite and the corresponding interest rate
risk limits.
At group level, Rabobank's interest rate risk is managed by the
Asset and Liability Committee Rabobank Group chaired by the
Chief Financial Officer. The Treasury is responsible for
implementing the decisions of this committee, while Risk
Management is responsible for measuring and reporting the
interest rate risk position.
The definition used for managing interest rate risk varies from the
IFRS definition of equity. For interest rate risk management, the
economic value of equity is defined as the present value of the
assets minus the present value of the liabilities together with the
present value of the off-balance-sheet items. Through the use of
hedge accounting and because a large proportion ofthe balance
sheet is carried at amortized cost (in IFRS terms) and is therefore
not exposed to value changes due to changes in market interest
rates, the effects ofthe value changes on IFRS capital will be
limited.
As part of its interest rate risk policy, Rabobank uses the following
two key indicators for managing and controlling interest rate risk:
Earnings at risk; the EaR is the largest deviation in negative
terms ofthe expected net interest income in the next 12
months as a result of different interest rates scenarios; and
Modified duration of equity.
Sections 4.5.1 and 4.5.2 provide further details on "Earnings at
risk" and "Modified duration" developments.
4.5.1 Earnings at Risk
Earnings at risk is calculated once a month based on a standard
interest-rate-sensitivity analysis. This analysis shows the main
deviation, in a negative sense, ofthe projected interest income
overthe next 12 months because of a scenario in which all money
market and capital market interest rates gradually increase by 2
percentage points, of a scenario in which all money market and
capital market interest rates gradually decrease by a maximum
of 2 percentage points, and two scenariosin which the yield curve
steepens or flattens. The projected interest rate income is based
on a scenario in which all interest rates and other rates remain
equal.
In 2018, Rabobank's net interest income suffers the most under
an interest rate downward scenario throughout the year. On 31 st
of December 2018 the EaR ended up at EUR 109 million, lower
than the EaR of EUR 148 million in 2017. This is mainly driven by
Nil risk management by ALCO/Treasury.
Earnings at Risk
3 1 December 2018 31 December 2017
Earnings at Risk 109 148
Split by main currencies
Earnings at Risk-EUR 76 104
Earnings at Risk-USD 32 37
4.5.2 Modified Duration
The Modified duration (MD) or duration of equity indicates by
what percentage the economic value of equity will fall if the
money market and capital market interest rates increase by one
percentage point. The Managing Board has set a lower limit of
0% and an upper limit of 6% for this purpose. Additional limits
apply for the basis point value (BPV) of equity and the delta
profile (BPV per term point) for equity.
Modified Duration
31 December December 31
2018 2017
Modified Duration Group level in EUR 2,80% 2,00%
Split by main currencies
Modified Duration - EUR 3,20% 2,30%
Modified Duration - USD -2,20% -3,40%
Market Risk arises from the risk of losses on trading book positions
affected by movements in interest rates, equities, credit spreads,
currencies and commodities. Risk positions acquired from clients
Annual Report 2018 - Consolidated Financial Statements
159
