Executive introduction
Interest-rate risk has returned to the centre of bank balance-sheet management. The problem is not simply whether rates rise or fall. More difficult exposures emerge when different parts of the yield curve move differently, deposit customers behave outside historical assumptions, hedging relationships change or the balance sheet evolves while rates are moving.
EBA work on IRRBB continues to emphasise behavioural assumptions, commercial margins, credit-spread risk and hedging. The management lesson is that IRRBB cannot be reduced to one sensitivity number. Economic value, earnings, customer behaviour and liquidity need to be assessed together.
Key takeaways
- EVE and NII are complementary measures and can point in different directions.
- Non-maturity deposit assumptions are often the most consequential behavioural inputs in IRRBB.
- Parallel shocks are insufficient because curve shape, basis and currency movements matter.
- Customer options create nonlinear exposure that contractual cash-flow assumptions can miss.
- Dynamic balance-sheet models are useful for planning but introduce additional management-assumption risk.
EVE and NII
Economic Value of Equity measures the present value difference between banking-book assets and liabilities. A rate shock changes the discounted value of future cash flows and therefore Delta EVE. Net Interest Income focuses on earnings over a shorter horizon and depends on repricing, deposit pricing, hedging and new business.
A bank can have modest NII sensitivity but significant EVE risk, or the reverse. ALCO should therefore understand both the short-term earnings and longer-term value perspective rather than optimising one metric independently.
Non-maturity deposits
Current and savings accounts may be contractually withdrawable immediately but behaviourally stable for years. Banks therefore estimate core balances, decay, repricing and deposit beta. A deposit beta can be represented as change in customer deposit rate divided by change in the reference market rate.
Historical behaviour may not remain stable. Digital switching, price comparison, inflation and intense deposit competition can make balances more rate sensitive. Models calibrated on long periods of low rates need explicit challenge using recent cycle data.
Curve and option risk
IRRBB scenarios should include steepening, flattening, short-rate shocks, long-rate shocks, inversions and basis changes. A hedge designed for a parallel shift can remain exposed to a curve twist.
Borrower prepayment, early repayment, deposit withdrawal and term-deposit breakage create optionality. The probability that customers exercise these options can itself depend on rates, so behavioural cash flows need to respond to the scenario.
Hedging and dynamic balance sheets
Hedges should be evaluated against the risk they are intended to offset and the scenarios under which basis, optionality or rollover can become important. A swap programme that manages duration may still leave meaningful earnings or customer-behaviour risk.
Dynamic models add new lending, maturities, deposit growth, repricing and management action. They support strategic planning, but static balance-sheet views remain useful because they isolate the exposure already embedded in the book.
Technical framework
EVE can be expressed conceptually as PV(Assets) - PV(Liabilities), while Delta EVE measures the change under a stressed curve. NII equals interest income minus interest expense over the selected horizon. A dynamic simulation can be written as NII_t = f(BalanceSheet_t, Rates_t, Behaviour_t, Pricing_t, Hedge_t). The key validation risk lies in the behavioural and management functions, not the arithmetic identity.
Practical example
If market rates rise by 200 basis points and a bank assumes deposit rates rise by only 60 basis points, the implied beta is 30%. If actual competition forces a 120 basis-point increase, the realised beta is 60% and projected NII can be materially overstated. A useful stress test therefore shocks both market rates and the behavioural beta.
What risk leaders should do now
- Revalidate deposit beta, decay and core-balance assumptions using recent data.
- Increase focus on non-parallel curve and basis shocks.
- Integrate EVE and NII in ALCO decision-making.
- Stress prepayment, withdrawal and other customer optionality.
- Test hedge performance across alternative curve shapes.
- Use static views for exposure control and dynamic views for strategic planning.
Frequently asked questions
Why do EVE and NII sometimes conflict?
They measure different horizons and cash-flow effects. A position can benefit near-term earnings while losing long-term economic value.
Why are non-maturity deposits difficult to model?
Their contractual maturity is very short, but behavioural stability and repricing can be much longer and can change across rate regimes.
Are regulatory parallel shocks enough?
No. Banks should also assess curve shape, basis, behavioural and optionality risks relevant to their own balance sheet.
Conclusion
IRRBB is fundamentally a balance-sheet and behavioural risk, not merely a yield-curve calculation. Rates are observable; customer response is estimated.
The strongest frameworks combine financial mathematics, recent behavioural evidence, independent validation, scenario diversity and disciplined ALCO governance.