CSRBB – Increasing Focus on Banking Book and Capital

Ravi Bhushan
Jul 21
11 min read

Updated: Nov 4

Contents

CSRBB Product Scope – Banking Book.
Aligning CSRBB Methodologies.
CSRBB Risk Assessment Methods.
CSSRBB Vs IRRBB – Holistic View.
Challenges faced by banks in incorporating CSRBB as Pillar II risk.
Best Practices for Managing CSRBB Regulatory Compliance.
Conclusion.
References.

Incorporating CSRBB into Pillar II Risk and Capital Requirements

Managing credit spread risk in the banking book (CSRBB) is crucial for effective risk management, especially given the increasing volume of sovereign and corporate bonds. CSRBB refers to banking instruments sensitive to credit spreads. It arises from changes and fluctuations in credit spreads, influenced by market credit risk or perceptions of liquidity, which impact banks' income and capital. Following the credit crises at Credit Suisse and SVB, increased regulatory scrutiny and rising interest rate exposure in Europe and the US underscore the importance of CSRBB.

Silicon Valley Bank’s (SVB) failure exposed vulnerabilities in portfolios sensitive to credit spreads, particularly those in mortgage-backed securities (MBS), despite no defaults. SVB's heavy exposure to long-duration fixed-income securities, including mortgage-backed securities (MBS) and U.S. Treasuries, held in the Held-to-Maturity (HTM) portfolio, suffered sharp declines as the Federal Reserve raised interest rates. This combination of duration exposure and widening credit spreads led to unrealised losses exceeding $15 billion in SVB’s HTM portfolio. Although these securities are deemed “safe” from credit risk, their long duration makes them vulnerable to interest rate and liquidity risks during stress. These factors prompted regulators to focus on credit spread risk in the banking book (CSRBB) and its measurement. It is now widely acknowledged that spread-sensitive instruments can significantly affect a bank’s economic value and solvency, even without a credit event occurring.

Efforts to incorporate CSRBB into Pillar II of the ICAAP are in the early stages, but awareness of credit spread risk in the banking book is growing. Basel and national regulators, including the ECB, PRA, and the Fed, emphasize that CSRBB assessment is essential in conjunction with IRRBB. Regulators are focusing on enhancing CSRBB modeling capabilities, particularly in stress testing and scenario analysis, while improving data quality and IT infrastructure to monitor the spread of risk in banking books and HTM securities. European banks have adopted the EBA CSRBB 2023 guidelines, marking a key milestone in risk management by integrating CSRBB into their capital frameworks, which are now a Pillar II requirement.

CSRBB targets credit spread risk from banking book instruments outside other frameworks, such as Interest Rate Risk in the Banking Book (IRRBB) and credit value adjustment (CVA). These risks encompass expected credit and jump-to-default risks. Understanding the instruments and valuation methods for CSRBB is crucial for determining accurate capital requirements and developing effective mitigation strategies. Shifts in CSRBB positions may necessitate capital adjustments for potential losses. These adjustments can overlap with other market risks, primarily interest rate and liquidity risks, emphasizing the necessity of proactive risk management.

CSRBB instruments play a crucial role in preventing double-counting of capital requirements. Managing CSRBB effectively requires risk measurement and stress testing to ensure optimal performance. Banks must include CSRBB in their Pillar II capital assessments and set concentration limits on bond portfolios to reduce exposure. Thus, Pillar II capital is allocated to CSRBB for planning and testing. Additionally, sovereign debt in liquidity buffers, like High-Quality Liquid Assets (HQLA), significantly impacts CSRBB exposure. Institutions with extensive sovereign bond holdings may require additional capital. The ambiguity surrounding CSRBB complicates defining its scope and differentiating between spread elements in the ICAAP. Since CSRBB risk measurement includes unique credit and liquidity spreads that differ from traditional credit valuation adjustments (CVA), banks must devise and develop innovative methods to address this uncovered risk. This CSRBB white paper will examine methodologies, challenges, and best practices regarding CSRBB's regulatory requirements.

CSRBB Product Scope – Banking Book

CSRRBB applies to banking book instruments sensitive to changes in credit spreads. It encompasses credit spreads, representing the market risk premium for credit quality, while market liquidity spreads denote the liquidity premium for market participation. Assets, liabilities, derivatives, and off-balance-sheet items are included in the CSRBB risk measurement. EBA regulatory guidelines urge banks to specify which items are included or excluded, particularly regarding sensitivity to credit spread risk. It is crucial to clearly distinguish between market liquidity, credit spreads, and idiosyncratic credit.

Assets, liabilities, derivatives, and off-balance-sheet scope items (e.g., loan commitments).
Instruments that do not show any connection to market prices or reference market curves are excluded from CSRBB.
Any exclusion must be appropriately justified and documented.

The banking book includes all securities and credit spread sensitivities. Instruments tied to trading book activities have credit spread risk captured by CVA and SA-CCR measures. A key uncertainty exists in liabilities, especially fixed-income securities. Banks must show that excluded items are either not sensitive to credit spread risk or covered by other measures. Instruments tied to liquid markets, such as sovereign debt and High Quality Liquid Assets (HQLA), or those indirectly connected to market prices, are included in the scope of CSRBB.

Exposure	Scope of CSRBB and Reason	Comments
Bonds	FVPL and FVOCI are fair value bonds. Bonds held at cost are included. Instruments accounted for at fair value cannot be excluded from CSRBB.
Performing Loans	FVPL and FVOCI bonds and price changes are not readily observable in the market.
Non-performing loans	Excluded from CSRBB
Idiosyncratic credit spread:	CSRBB excludes the spread risk component from individual asset credit characteristics (e.g., individual credit ratings).	Covered under CVA
Directly Traded Instruments	Instruments actively traded on recognised markets are included. *Indirectly Linked Instruments*: Instruments priced based on market curves or combinations are also included.
Derivatives and Repos	Derivatives, repos, or reverse repos are excluded from CSRBB.	Covered under CVA
CSRBB-Mitigating Instruments	Instruments such as bond futures, CDS, and forward sales and purchases that mitigate CSRBB must be included.

Table 1- Scope of CSRBB Product Scope

Aligning CSRBB Methodologies

CSRRBB modeling encompasses instruments sensitive to changes in credit spreads and applies to banks with significant interest rate exposure, including credit-sensitive deposits and loans. Banks recalculate the Economic Value of Equity (EVE) and Net Interest Income (NII) under stress scenarios and the Delta from the Baseline for CSRBB capital requirements. Risk managers also employ various methods, notably risk-based scenario shock. CSRBB must be modeled separately from IRRBB to prevent double-counting. A significant portion of CSRBB exposure comes from liquidity reserves, making their composition crucial for determining capital requirements. Banks holding numerous sovereigns or similarly rated bonds may need additional capital to mitigate the risks associated with credit spreads. Accurately assessing CSRBB necessitates evaluating how changes in credit spreads affect banking book assets and liabilities, and excluding interest rate effects is vital to this analysis.

Steps for the CSRBB measurement and Scenarios Analysis – Capital Requirement

CSRBB Risk Assessment Methods

Scenario Type	Application	Description
Parallel Credit Spread Shock	ΔEVE, ΔNII	Uniform shift (e.g., +100 bps) across all maturities
Non-Parallel (Term Structure)	ΔEVE	Curve steepening or flattening; different shifts by tenor
Rating-Based Spread Shock	ΔEVE, ΔNII	Apply higher stocks to lower credit ratings (e.g., AAA +30bps, BBB +100bps)
Historical Event Replication	ΔEVE, ΔNII	Reapply spread moves from past crises (e.g., 2008, 2020)
PCA-Based Systematic Shock	ΔEVE	Apply 1st principal component to represent the market-wide spread shock

CSSRBB Vs IRRBB – Holistic View

CSRBB and IRRBB are distinct and need to be managed separately. Credit spreads and interest rates can move independently, especially in times of financial stress, and their combined effects can significantly impact a bank’s economic value and earnings.

Feature	CSRBB (Credit Spread Risk in Banking book)	IRRBB (Interest rate risk in banking book)
Risk drivers	Changes in credit spreads (non-default-related), Changes in interest rates (e.g., risk-free curves) and liquidity spreads	Changes in interest rates (e.g., risk-free curves)
Instruments covered	Credit instruments (e.g., corporate bonds, loans)	All rate-sensitive instruments (loans, deposits, bonds)
Focus of CSRBB	Market perception of creditworthiness (Credit Spread risk) and liquidity spread	General movement in interest rates/yield curves
Stress Testing Focus	Credit spread shocks (sectoral, rating-based, systemic)	Rate shocks (parallel, steepener, flattening, etc.)
Strategic importance	Used in understanding credit risk pricing and bond value volatility	Used in ALM strategy, pricing, and hedging decisions
Measurement approaches	Scenario and sensitivity analysis on credit spreads	Gap analysis, EVE, NII simulation, repricing models
Valuation risk sensitivity	Affected by spread sensitivity (e.g., CS01/DVCS)	Affected by interest rate sensitivity (e.g., DV01)
Accounting treatment	Applies even if instruments are held at amortised cost	Applies to both fair value and amortised instruments
Economic impact	Impacts perceived credit risk premium and valuation	Impacts funding cost, pricing, earnings, and value
Regulatory framework	EBA Guidelines, BCBS 516	Basel III, BCBS 368, EBA IRRBB Guidelines

Table 3- CSRBB Vs IRRBB

Challenges faced by banks in incorporating CSRBB as Pillar II risk

The growing focus on Credit Spread Risk in the Banking Book (CSRBB) introduces essential regulatory oversight, encourages increased bond holdings, and heightens sensitivity to interest rate fluctuations. For banks, determining how to allocate Pillar 2 capital to address Credit Spread Risk in the Banking Book (CSRBB) remains a vital and ongoing challenge. Given the intricate connections between CSRBB risk management and other risks, such as Credit Valuation Adjustment (CVA), Interest Rate Risk in the Banking Book (IRRBB), jump-to-default risk, and market risk, institutions must explore practical strategies to balance their capital reserves while ensuring they do not overextend their resources.

Vague Regulatory Framework: CSRBB’s regulatory guidance on its management has been somewhat unclear. Consequently, monitoring and assessment have not progressed as significantly as frameworks like IRRBB, but this is gradually improving as banks increasingly face credit spread risks. There is some uncertainty regarding liabilities, particularly concerning banks' debt securities (bonds).
Defining the Scope of CSRBB: Instruments are materially exposed to credit spread risk, particularly in the banking book (e.g., loans at amortised cost).
- Interplay with Other Risks: CSRBB is closely connected to various market risks, primarily interest rate and liquidity. Understanding how it interacts with these risks is essential for effective risk management
- Interpretation Variability: Different banks have adopted unique methods to calculate CSRBB, which can lead to inconsistencies in risk management, even among those working within the same regulatory framework.
Liquidity Reserves and Capital Requirement: Since 90% of CSRBB's exposure is derived from liquidity reserves, understanding the composition of these reserves is crucial when evaluating its capital needs. Banks holding significant amounts of sovereign or similarly rated bonds might need to set aside extra capital to safeguard against the risks associated with potential credit fluctuations and spreads.
Standards Scenarios not defined: Capital levels can vary significantly across different institutions. To facilitate CSRBB calculations, some banks utilise predefined shocks, applying parallel shifts in credit spreads (e.g., a 100-bps increase or decrease) to assess their impact on capital. This method helps us to understand how market changes influence capital levels, ensuring more effective risk management and earnings.
Methodologies and measurement approach: The calculation should clearly distinguish between market liquidity, credit spread, and the idiosyncratic spread. However, we notice a gap in clear guidance on how to systematically isolate these components, especially for complex instruments with embedded liquidity risk. Additionally, it’s important to remember that credit spread risk is non-linear and can be influenced by interest rates, market sentiment, and other factors.
Data Requirement: Stress tests present significant implementation challenges and require strong data and analytical capabilities. Banks require access to detailed historical data, which is crucial for refining assumptions to better reflect current market conditions. Performing stress tests involves sophisticated data inputs and models, which can pose more difficulties for smaller banks or those with less robust risk management systems.
Risk and capital requirement framework: Allocating capital for CSRBB related to ICAAP is about smartly managing liquidity reserves and the duration of sovereign debt. You'll find that banks with larger reserves typically allocate more capital for CSRBB risk. For instance, when sovereign debt is included in liquidity buffers, such as High Quality Liquid Assets (HQLA), it can increase the exposure to CSRBB. So, setting those CSRBB exposure limits is a careful balancing act between maintaining reserves and achieving capital efficiency and profitability.

Best Practices for Managing CSRBB Regulatory Compliance

Navigating the uncertainties of CSRBB can be challenging, but banks have effective strategies to address these challenges. Leading banks find that a structured and comprehensive approach helps them manage CSRBB risk effectively, integrating it seamlessly into their overall risk management frameworks. Let’s explore some potential strategies for managing CSRBB risk throughout the economic cycle:

1. Comprehensive Risk Assessment

Banks are encouraged to recognise credit spread risk instruments and establish Credit Spread Risk-Based Business (CSRBB) guidelines. A flexible stress-testing framework helps assess how credit spreads and liquidity shocks impact balance sheet scope. With smaller CSRBB exposures, banks typically lean toward simpler methods, such as CS01 or standard shocks, often avoiding comprehensive Value at Risk (VaR) or expected shortfall, and they may limit investments until they receive further regulatory guidance. Conversely, larger institutions may use CSVaR for a more sensitive CSRBB estimation, which accounts for diversification effects and aligns with the tools used for calculating economic capital.

2. Incorporating CSRBB into Capital Planning

Banks will allocate Pillar 2 capital for CSRBB risk by considering credit and liquidity spread sensitivities. We should assign capital to longer-duration, lower-quality, and less liquid instruments. By incorporating CSRBB risk into our Pillar 2 capital planning, we can also consider the composition of the liquidity buffer and how credit spreads impact EVE and NII. Regular stress testing for gradual and severe shocks will be key in assessing potential losses from adverse credit movements.

3. Regular Monitoring of Credit Spread Movements

Banks should closely monitor real-time credit spread movements to prepare for both market-wide and specific shocks that may arise. Regulatory guidelines recommend that institutions actively track and report changes in market liquidity spreads, allowing them to maintain a substantial buffer against liquidity risk challenges. Furthermore, banks must efficiently manage their liquidity reserves and establish concentration limits on sovereign and corporate bond holdings to strike a balance between risk and profitability.

4. Balancing Capital with Liquidity Needs

Banks must allocate capital to CSRBB while ensuring adequate liquidity for their daily operations. In these constantly changing markets, they must maintain sufficient liquid assets to meet regulatory ratios, such as the Liquidity Coverage Ratio (LCR), and manage potential credit spread losses. A practical approach to dynamic liquidity management is crucial for promptly responding to market fluctuations and maintaining robust capital buffers.

5. Diversification and Portfolio Management

Banks must diversify their credit risk to mitigate concentration risk from sovereign and correlated bonds by investing in a range of assets with varying credit ratings and maturities. They should adopt a measurement approach that aligns with their risk management framework to ensure the accurate allocation of economic capital. Additionally, banks should consider hedging strategies to reduce the impact of widening liquidity spreads during economic or geopolitical stress,

6. Aligning with Regulatory Expectations

Banks must continually comply with regulatory guidelines by adapting their strategies to align with the ever-evolving regulations and expectations set by Basel guidelines. Seek further clarity from local regulators regarding the scope and methodologies for the CSRBB reporting requirement under ICAAP.

7. Technology and Data Infrastructure

To ensure smooth integration for CSRBB, a robust reference data infrastructure and a focus on credit products are essential for effectively tracking changes in credit spreads and understanding their influence on liquidity buffers and capital requirements.

Conclusion

The approach used to measure credit spread risk in the banking book (CSRBB) varies according to each bank's unique risk exposure. Banks must consider factors such as regulatory frameworks and portfolio complexity when making decisions. Simpler methods, like CS01 or standard shocks, are effective for banks with limited exposure contrast and perform adequately. Meanwhile, larger banks that hold significant amounts of sovereign and corporate bonds gain valuable insights from advanced techniques, such as credit spread value at risk (CSVaR) enhancement. These sophisticated methods improve our understanding of systemic risk and potential losses. Additionally, they enable efficient risk management, allowing for better CSRBB management while ensuring compliance with regulatory requirements and optimizing capital structures. The quantitative impact of credit spread risk, measured through stress testing and scenario analysis, is invaluable for understanding how interest rate and credit spread movements can affect a bank’s bottom line.

Regardless of the method, it is essential to establish strong risk management frameworks, clear policies, and robust processes for measuring and managing CSRBB, which are imperative. This includes comprehensive reporting and review procedures. Additionally, the Internal Capital Adequacy Assessment Process (ICAAP) should seamlessly integrate CSRBB risk into its framework to maintain adequate capital and liquidity buffers. As we navigate the ever-changing economic and geopolitical landscapes, continually refining our stress testing and liquidity management frameworks is crucial. By quantifying the credit and liquidity components of CSRBB, banks can better adjust their risk exposure and comply with regulatory scrutiny from the European Banking Authority (EBA) and regulatory expectations. It’s essential to remember that best practices for measuring CSRBB will adapt and evolve in response to market conditions, regulatory expectations and guidelines, and data availability. To effectively manage CSRBB risk, banks should remain flexible and responsive to regulatory guidance and market changes.

References

Glossary

CSRBB	Credit spread risk in Banking book
EVE	Economic Value of Equity
NII	Net Interest Income
CVA	Credit Value Adjustments
ICAAP	Internal Capital Adequacy Assessment Process (ICAAP)
EBA	European Banking Authority
IRRBB	Interest rate risk in the banking book
HQLA	High-Quality Liquid Assets
PCA	Principal Component Analysis
OIS	Overnight Index Swap
FVPL	Fair value through profit or loss bond
FVOCI	Fair Value other comprehensive income
CDS	Credit Default Swap
CSVaR	Credit Spread Value at Risk
SVB	Silicon Valley Bank
MBS	Mortgage-backed securities
PRA	Prudential Regulatory Authority ( UK)
FED	The Federal Reserve System (the Fed) is the central bank of the United States.
HTM	Held to Maturity ( Banking Book)

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