Structural interest-rate risk

Structural interest-rate risk refers to the potential alteration of a company’s net interest income and/or total net asset value caused by variations in interest rates. A financial institution’s exposure to adverse changes in market rates is a risk inherent in the banking business, while becoming an opportunity to create value.

The variations in interest rates have effects on the Group’s net interest income, from a medium and short-term perspective, and on its economic value if a long-term view is adopted. The main source of risk resides in the time mismatch that exists between repricing and maturities of the asset and liability products comprising the banking book. This is illustrated by Chart 34, which shows the gap analysis of BBVA’s structural balance sheet in euros.

Rates have remained at low levels in 2010, with a reduction in long-term rates consistent with the slowdown in business activity. This market scenario has been managed in advance by the Financial Management unit, which through the Asset and Liability Committee (ALCO), is in charge of maximizing the economic value of the banking book and preserving net interest income to ensure recurrent earnings. And it does so while making sure that exposure levels match the risk profile defined by the Group’s management bodies and that a balance is maintained between expected earnings and the risk level borne. In order to facilitate proper management of balance-sheet risk, a transfer pricing system exists that centralizes the Bank’s interest rate risk on ALCO’s books.

The Group’s management is based on structural interest rate risk measurements, whose control and monitoring is performed in the Risk area, acting as an independent unit to guarantee that the risk management and control functions are appropriately segregated. This policy is in line with the Basel Committee on Banking Supervision recommendations. To do so, Risks is responsible for designing models and measurement systems, together with the development of monitoring, reporting and control policies. It also performs monthly measurements of interest rate risk and performs risk control and analysis, which is then reported to the main governing bodies, such as the Executive Committee and the Board of Director’s Risk Committee.

The Group’s structural interest rate risk measurement model is based on a sophisticated set of metrics and tools that enable its risk profile to be monitored. For accurately characterizing the balance sheet, analysis models have been developed to establish assumptions dealing fundamentally with expected early loan amortizations and the behavior of deposits with no explicit maturity. Moreover, in order to take into account additional sources of cash flow mismatch risk, not only parallel movements but also changes in the slope and curvature of the interest rate curve, a model for simulating interest rate curves is also applied to enable risk to be quantified in terms of probabilities. This simulation model, which also considers the diversification between currencies and business units, calculates the earnings at risk (EaR) and economic capital, defined as the maximum adverse deviations in net interest income and economic value, respectively, for a particular confidence level and time horizon. All this in addition to measurements of sensitivity to a standard deviation of 100 basis points for all the market yield curves. Chart 35 shows the structural interest rate profile of the main entities of the BBVA Group, according to their sensitivities.

The maximum negative impacts, in terms of both net interest income and value, are controlled in each of the Group’s entities through a limits policy. The risk appetite of each entity, as defined by the Executive Committee, is expressed through the limits structure, which is one of the mainstays in control policies. Active balance sheet management has enabled its exposure to be maintained in keeping with the Group’s target risk profile, as presented in Chart 36, which shows average limits use in each Group entity during 2010.

The risk measurement model is supplemented by the analysis of specific scenarios and stress tests. In 2010, stress tests have been particularly relevant, and analysis of extreme scenarios has continued to be reinforced in the event of possible changes in current rate levels. At the same time, forecast scenarios by the Research Department continued to be evaluated, together with other severe risk scenarios drawn up from an analysis of historical data and the change in certain observed correlations. In addition, monitoring of the contribution to risk by portfolios, factors and regions, and its subsequent integration into joint measurements, continued during the year.

34: Gap of maturities and repricing of BBVA’s structural balance sheet in euros

(Million euros)

35: Structural interest rate risk profile. BBVA Group

36: Structural interest rate risk. Average use of limits in 2010