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On 12 February 2025, the Hong Kong Monetary Authority (HKMA) published a circular on interest rate risk management1 (“the circular”) which provides further guidance with regard to disclosure of capital adequacy ratios (CARs) adjusted for unrealized losses on debt securities investment and summarizes the industry good practice observed among peer banks regarding the use of behavioral models for measuring interest rate risk in the banking book (IRRBB) from the below five aspects:
- Model governance and senior management oversight
Robust governance frameworks should encompass well-established policies and procedures, comprehensive documentation, adequate senior management oversight, and effective internal audit function.
- Modeling approaches
Advanced modeling approaches should consider granular segmentation of non-maturity deposit (NMD), the incorporation of forward-looking elements – including but not limited to market and macroeconomic trends, technological advancement and business strategies, and the scenario-specific modeling of interest rate effects on NMD.
- Model performance monitoring and validation
Practical model performance monitoring processes include regular backtesting and sensitivity analyses. Independent model validation should be performed during pre-implementation phase, and annual validation after the model has been implemented. Ad hoc model review should be introduced when there are abrupt market trends or idiosyncratic events that may impact the validity of the model assumptions.
- Use of model outputs
Effective utilization of model outputs covers both regulatory reporting and the development of strategies for hedging IRRBB and managing deposits.
- Third–party vendor or group-level models
Bank- and jurisdiction-specific calibration and adaptations should be incorporated for group level or third-party vendor models, along with in-house independent validation and proper oversight.
In this material, we share EY’s insights and recommendations in response to the circular with a focus on IRRBB behavioral modeling.