Westpac Group Pillar 3 Report March 2013 - Iguana IR Sites

PILLAR 3 REPORT
INTEREST RATE RISK IN THE BANKING BOOK (IRRBB)
Interest Rate Risk in the Banking Book (IRRBB) is the risk to interest income arising from a mismatch between the
duration of assets and liabilities that arises in the normal course of business activities.
Approach
The banking book activities that give rise to market risk include lending activities, balance sheet funding and
capital management. Interest rate risk, currency risk and funding and liquidity risk are inherent in these activities.
Group Treasury’s Asset & Liability Management (ALM) unit is responsible for managing market risk arising from
Westpac’s banking book activity.
All material regions, business lines and legal entities are included in Westpac’s IRRBB framework.
Asset and liability management
ALM manages the structural interest rate mismatch associated with the transfer priced balance sheet, including
the investment of Westpac’s capital to its agreed benchmark duration. A key risk management objective is to
achieve reasonable stability of Net Interest Income (NII) over time. These activities are performed under the
oversight of MARCO and the Financial Markets & Treasury Risk (FMTR) unit.
Net Interest Income sensitivity
NII sensitivity is managed in terms of the net interest income-at-risk (NaR) modelled over a three year time horizon
to a 99% confidence interval for movements in wholesale market interest rates. A simulation model is used to
calculate Westpac’s potential NaR. The NII simulation framework combines the underlying statement of financial
position data with assumptions about runoff and new business, expected repricing behaviour and changes in
wholesale market interest rates. Simulations using a range of interest rate scenarios are used to provide a series
of potential future NII outcomes. The interest rate scenarios modelled include those projected using historical
market interest rate volatility as well as 100 and 200 basis point shifts up and down from current market yield
curves. Additional stressed interest rate scenarios are also considered and modelled.
A comparison between the NII outcomes from these modelled scenarios indicates the sensitivity to interest rate
changes. On and off-balance sheet instruments are then used to manage this interest rate risk.
NaR limit
The BRMC has approved a NaR limit. This limit is managed by the Treasurer and is expressed as a deviation from
benchmark hedge levels over a one-year rolling time frame, to a 99% level of confidence. This limit is monitored by
FMTR.
VaR limit
The BRMC has also approved a VaR limit for ALM activities. This limit is managed by the Treasurer and monitored
by FMTR. Additionally, FMTR sets structural risk limits to prevent undue concentration of risk.
Structural foreign exchange rate risk
Structural foreign exchange rate risk results from the generation of foreign currency denominated earnings and
from Westpac's capital deployed in offshore branches and subsidiaries, where it is denominated in currencies
other than Australian dollars. The Australian dollar equivalent of offshore earnings and capital is subject to change
as exchange rates fluctuate, which could introduce significant variability to Westpac's reported financial results.
ALCO provides oversight of the appropriateness of foreign exchange hedges on earnings.
Risk reporting
Interest rate risk in the banking book risk measurement systems and personnel are located in Sydney, Auckland,
Singapore and Shanghai. These include front office product systems, which capture all treasury funding and
derivative transactions; the transfer pricing system, which captures all retail and other business transactions; nontraded
VaR systems, which calculate Group Treasury VaR; and, the NII system, which calculates NaR.
Daily monitoring of current exposure and limit utilisation is conducted independently by FMTR, which monitors
market risk exposures against VaR, NaR and structural risk limits. Management reports detailing structural
positions and VaR are produced and distributed daily for use by dealers and management across all stakeholder
groups. Monthly and quarterly reports are produced for the senior management market risk forums of MARCO and
BRMC respectively to provide transparency of material market risks and issues.
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