EBA consults on draft Guidelines on corrections to modified duration for debt instruments

The European Banking Authority (EBA) launched today a public consultation on draft Guidelines on corrections to modified duration for debt instruments. These Guidelines aim to establish what type of adjustments to the modified duration (MD) – as defined according to the formulas in the Capital Requirements Regulation (CRR) – have to be performed in order to appropriately reflect the effect of the prepayment risk. The consultation runs until 22 June 2016.

The CRR establishes two standardised methods to compute capital requirements for general interest rate risk. One is the so-called maturity-based calculation for general interest risk, while the other one is the duration-based calculation of general risk.

These draft Guidelines are relevant for institutions applying the duration-based calculation, and propose two approaches to correct the modified duration calculation. The first approach treats the instrument with embedded optionality as if it were a combination of a plain vanilla bond and an option whilst the second approach proposes to calculate directly the change in value of the whole instrument subject to prepayment risk. The Guidelines also propose to compute additional adjustments to reflect the negative convexity as well as transaction costs and any relevant behavioural factors that may affect the modified duration of the instrument.

The EBA statement and the consultation paper can be found here.

Lavanya Rathnam

Lavanya Rathnam is an experienced technology, finance, and compliance writer. She combines her keen understanding of regulatory frameworks and industry best practices with exemplary writing skills to communicate complex concepts of Governance, Risk, and Compliance (GRC) in clear and accessible language. Lavanya specializes in creating informative and engaging content that educates and empowers readers to make informed decisions. She also works with different companies in the Web 3.0, blockchain, fintech, and EV industries to assess their products’ compliance with evolving regulations and standards.

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