Managing IRRBB EVE and NMD Modeling: The SAP Integrated Approach

Introduction: The New Paradigm of IRRBB In the wake of the Basel Committee on Banking Supervision (BCBS) 368 standards and the subsequent European Banking Authority (EBA) Guidelines, the management of Interest Rate Risk in the Banking Book (IRRBB) has undergone a fundamental transformation. It has evolved from a specialized, periodic risk exercise into a deeply integrated, daily operational requirement that bridges the gap between Risk, Finance, and Treasury departments. The regulatory landscape now demands a higher degree of transparency, granularity, and methodological rigor. Central to this evolution is the calculation of Economic Value of Equity (EVE) and the sophisticated modeling of Non-Maturing Deposits (NMDs). For global financial institutions, the complexity of these requirements—coupled with the sheer volume of data involved—has rendered traditional, siloed systems and spreadsheet-based models obsolete. SAP has addressed these challenges by developing a robust, end-to-end architecture. By integrating SAP Treasury and Risk Management (TRM), SAP Financial Products Subledger (FPSL), and SAP Profitability and Performance Management (PaPM), SAP offers a unified ecosystem that transforms regulatory compliance into a strategic advantage. "Risk management is not about simply eliminating risk; it's about properly identifying, pricing, and managing it to ensure that the rewards justify the exposure." 1. The Core Engine: SAP TRM for EVE Sensitivity The Economic Value of Equity (EVE) is a cash-flow-based valuation metric that measures the change in the net present value of the bank’s entire balance sheet. Unlike Net Interest Income (NII), which focuses on short-term earnings volatility, EVE captures the long-term impact of interest rate changes on the bank’s total economic worth. Within the SAP architecture, SAP TRM serves as the primary valuation and risk engine. Its role is to translate raw contractual data into risk-sensitive cash flows and valuations. Granular Cash Flow Generation The foundation of any EVE calculation is the accuracy of the underlying cash flows. SAP TRM generates highly granular cash flows for every instrument in the banking book. This includes: Standard Banking Products: Fixed and floating rate loans, mortgages, and term deposits. Wholesale Funding: Commercial paper, bonds issued, and interbank borrowings. Derivatives: Interest rate swaps, caps, floors, and cross-currency swaps used for hedging. Embedded Options: The engine accounts for optionality, such as prepayment rights in retail loans, which are critical for an accurate EVE assessment. Regulatory Stress Testing and Scenarios Under BCBS 368, banks are required to measure $\Delta EVE$ under six prescribed interest rate shock scenarios. SAP TRM comes pre-configured to execute these shocks automatically: Parallel Up: A uniform increase across all maturities. Parallel Down: A uniform decrease, often subject to a "zero floor" or specific regulatory floors. Steepener: Short-term rates decrease while long-term rates increase. Flattener: Short-term rates increase while long-term rates decrease. Short Rate Up: A significant spike in the short end of the curve. Short Rate Down: A significant drop in the short end of the curve. Advanced Sensitivity Analytics SAP TRM calculates the sensitivity of the balance sheet by discounting projected cash flows using risk-free yield curves. The system allows for the definition of multiple yield curve frameworks, enabling banks to distinguish between "risk-free" discounting and "funding-spread" adjusted discounting. This provides a clear, mathematical view of the bank’s vulnerability to rate shifts, specifically highlighting the "outlier test" threshold where a decline in EVE exceeding 15% of Tier 1 Capital triggers regulatory scrutiny. "The balance sheet is the ultimate scorecard. In banking, the mastery of Interest Rate Risk is the difference between long-term resilience and sudden vulnerability." 2. The NMD Modeling Challenge: Moving Beyond Contractual Terms Non-Maturing Deposits (NMDs)—such as current accounts, demand deposits, and flexible savings—represent one of the most significant sources of funding for retail banks. However, they are "less amenable to standardization" because they lack a contractual maturity date. While a customer can withdraw their funds at any time, in aggregate, these deposits tend to stay on the balance sheet for years, providing a stable source of funding. Regulatory bodies require banks to segment NMDs into stable and non-stable parts. The stable portion must be further analyzed to identify the core balance—that which is unlikely to be withdrawn even in a stressed environment or when interest rates rise significantly. Behavioral Modeling with SAP PaPM SAP manages this complexity through the powerful analytical capabilities of SAP PaPM. Unlike traditional engines, PaPM can ingest massive volumes of historical transaction data to perform behavioral analysis. Segmentation: Deposits are segmented by customer type (Retail vs. Wholesale), product type, and "transactability" (e.g., salary accounts vs. pure savings). Pass-through Rate (Beta) Calculation: PaPM calculates the "deposit beta"—the degree to which the bank must increase deposit rates in response to market rate hikes to prevent attrition. Decay and Attrition Rates: By analyzing historical outflows, PaPM determines the expected life of different deposit segments. The 5-Year Regulatory Cap A critical constraint in EVE modeling is the regulatory cap on the average repricing maturity of NMDs. BCBS guidelines typically impose a 5-year average cap on the core portion. SAP TRM allows risk managers to apply these behavioral "maturity profiles" to NMDs. Instead of showing NMDs as maturing "overnight" (their contractual state), the system "slots" the core balances into specific time buckets (e.g., 1 month to 5 years). This ensures that the duration of the NMDs is accurately represented in the EVE calculation, preventing an artificial mismatch between long-term assets and overnight liabilities. Dynamic Simulation and "What-If" Analysis While TRM handles the "as-is" static EVE, PaPM provides a dynamic simulation layer. Banks can run "What-If" scenarios to see how their EVE ratio would change if: Depositor behavior shifts (e.g., a "dash for cash" or higher-than-expected attrition). The bank changes its pricing strategy (adjusting the deposit beta). Macroeconomic factors influence the "stickiness" of corporate deposits. 3. Consistency Between Risk and Finance: The Role of FPSL One of the greatest pain points for modern banks is the "data gap" between the Risk department and the Finance department. Finance reports under IFRS 9 or local GAAP, while Risk reports under IRRBB guidelines. Discrepancies between these two views often lead to manual reconciliations, audit findings, and strategic confusion. SAP solves this through the Integrated Finance and Risk Architecture (IFRA), centered around SAP Financial Products Subledger (FPSL). Unified Data and the "Single Source of Truth" SAP FPSL acts as a high-volume subledger that stores granular contract data, valuations, and accounting entries. By using FPSL, the valuations used for IFRS 9 (Accounting) and IRRBB (Risk) are inherently reconciled. When SAP TRM calculates a discounted present value for an instrument, that same data point can be used to inform the Fair Value disclosures in the financial statements. Transparency and Auditability Regulatory standards emphasize "Model Governance" (Pillar 2). Regulators want to be able to trace a high-level $\Delta EVE$ figure back to the individual contracts that generated it. The subledger approach of FPSL provides a clear, immutable audit trail. Every movement in the EVE calculation can be traced back to: Market data changes (yield curve shifts). Behavioral model changes (NMD profile updates). New business volume or portfolio aging. This transparency is vital for satisfying the internal and external audit requirements of the EBA and other national supervisors. "Without a single source of truth, risk management is just an educated guess. Integration between Finance and Risk is no longer an option—it is a regulatory and operational necessity." 4. Beyond Compliance: Strategic Asset Liability Management (ALM) The ultimate goal of the SAP IRRBB solution is not merely to "tick a box" for the regulator, but to enable Strategic ALM. When a bank has a clear, automated view of its EVE and NII (Net Interest Income) sensitivities, it can move from defensive reporting to offensive balance sheet optimization. Balancing EVE and NII There is often a trade-off between protecting EVE and protecting NII. For example, a bank might use long-term Interest Rate Swaps to hedge the EVE risk of its fixed-rate mortgage portfolio. However, if interest rates fall, those swaps might negatively impact the bank's short-term NII. By integrating EVE metrics from TRM/FPSL with NII simulations in PaPM, the Treasury department can perform "Macro-Hedge" optimization. They can determine the precise amount of hedging required to keep the EVE decline within the 15% Tier 1 Capital limit while minimizing the volatility of the bank’s quarterly earnings. Funds Transfer Pricing (FTP) The behavioral models developed in PaPM for NMDs are not just for risk—they are also the foundation for Funds Transfer Pricing (FTP). The "liquidity premium" and "interest rate risk premium" assigned to branches for gathering deposits can be calculated based on the same "core" and "non-core" logic used for EVE. This ensures that the bank’s commercial strategy is perfectly aligned with its risk appetite. "Compliance should be the floor, not the ceiling. True leaders use regulatory frameworks like BCBS 368 to build more robust, data-driven organizations." — Strategic ALM Advisor 5. Technical Implementation: The SAP Advantage Implementing a comprehensive IRRBB solution requires a platform that can handle massive data volumes with high performance. SAP’s use of S/4HANA as the underlying database provides several technical advantages: In-Memory Processing: Calculating EVE across millions of contracts and six different shock scenarios requires significant computational power. S/4HANA allows these calculations to happen in minutes rather than hours. Real-time Integration: As new loans are booked in the core banking system, they flow into FPSL and TRM, allowing for near-real-time monitoring of the EVE ratio. Scalability: The SAP architecture is designed to grow with the bank, handling increasing complexity in behavioral modeling and expanding regulatory requirements across multiple jurisdictions. Conclusion: IRRBB Is Not a Risk Metric — It Is the Operating System of the Balance Sheet Interest Rate Risk in the Banking Book is still widely treated as a regulatory calculation. That interpretation is already obsolete. Under BCBS 368, EVE is not asking how much risk a bank has—it is asking whether the balance sheet itself is structurally coherent. A bank that cannot explain, at any point in time, why its Economic Value changes under rate stress does not have an IRRBB problem. It has an architectural one. Non-Maturing Deposits sit at the center of this misconception. They are neither overnight liabilities nor behavioral footnotes. They are embedded options written by customers and priced—often unconsciously—by the bank. Institutions that model NMDs with static averages and disconnected assumptions are not being conservative; they are blind. The resulting EVE figures may pass regulatory thresholds, but they systematically misallocate capital and mask convexity until it is too late. The real shift is not methodological. It is structural. When valuation, behavior, and accounting coexist in separate systems, IRRBB becomes a reporting exercise by construction. When they are unified—through SAP TRM, PaPM, and FPSL on a single in-memory architecture—IRRBB becomes a real-time decision framework. The balance sheet stops being a static stock of positions and becomes a dynamic system whose risk, profitability, and capital consumption can be engineered deliberately. This is what a true Digital Twin of the balance sheet enables: not just transparency, but intentionality. At that point, the 15% Tier 1 EVE threshold is no longer a limit to fear—it is a design constraint. Hedge ratios are no longer defensive overlays, but structural choices. Deposit pricing ceases to be commercial intuition and becomes capital optimization. Funds Transfer Pricing stops rewarding volume and starts rewarding stability. Banks that continue to treat IRRBB as a compliance domain will remain reactive, perpetually explaining yesterday’s numbers. Banks that treat IRRBB as the operating system of the balance sheet will define tomorrow’s profitability. In the next cycle of banking winners, the advantage will not belong to those with the most sophisticated models, but to those with the most integrated architecture—where every basis point of interest rate risk is traceable, accountable, and consciously deployed in service of economic value. IRRBB is no longer about measuring risk. It is about deciding what kind of bank you are building. "In the modern regulatory landscape, the integration between Finance and Risk is no longer an option but a strategic necessity. By transforming the balance sheet into a 'Digital Twin' through SAP's unified architecture, banks move beyond mere compliance to achieve true Capital Optimization." Connect and Stay Informed: Join the Conversation: Connect with fellow professionals in the SAP Banking Group on LinkedIn. https://www.linkedin.com/groups/92860/ Stay Updated: Subscribe to the SAP Banking Newsletter for the latest insights. https://www.linkedin.com/newsletters/sap-banking-6893665983048081409/ Join my readers on Medium where I explore Capital Optimization in depth. Follow for actionable insights and fresh perspectives https://medium.com/@ferran.frances Explore More: Visit the SAP Banking Blog for in-depth articles and analyses. https://sapbank.blogspot.com/ Connect Personally: Feel free to send a LinkedIn invitation; I'm always open to connecting with like-minded individuals. ferran.frances@gmail.com I look forward to hearing your perspectives. Kindest Regards, Ferran Frances-Gil. #IRRBB #BankingRisk #AssetLiabilityManagement #ALM #RiskManagement #BankingRegulations #BCBS368 #EBAGuidelines #InterestRateRisk #FinancialStability #CapitalOptimization #FerranFrances