Strategic Management of IRRBB: Advanced Modeling of EVE, NMDs, and CSRBB under the New EBA Heatmap Standards

Introduction The management of Interest Rate Risk in the Banking Book (IRRBB) has evolved from a compliance exercise into a core strategic function for financial institutions. In the current economic landscape, characterized by the stabilization of interest rates after a period of rapid hikes and the subsequent transition to a more neutral environment, the European Banking Authority (EBA) has finalized its "Heatmap" implementation. This new regulatory framework demands a level of granularity and sophistication in modeling that exceeds previous standards, particularly concerning Economic Value of Equity (EVE), Net Interest Income (NII), and the modeling of Non-Maturity Deposits (NMDs). 1. The New Regulatory Paradigm: Post-2026 Context The recent EBA report marks a milestone in the harmonization of IRRBB supervision across the European Union. While the "Outlier Test" (SOT) results show a significant decrease in banks breaching the 15% Tier 1 capital threshold (down to 0.66% in late 2024), this improvement is partly due to better rate environments rather than solely to risk mitigation. The EBA now emphasizes not just the level of risk, but the robustness of the models. For institutions using integrated platforms like SAP or specialized ALM software, the challenge lies in translating these qualitative expectations into quantitative parameters. 2. Modeling Non-Maturity Deposits (NMDs): The 5-Year Threshold The most critical aspect of IRRBB for retail-heavy banks is the treatment of NMDs. Since these instruments lack a contractual maturity, banks must "model" their behavior to determine how much of the balance is "core" (stable and insensitive to rate changes) and how much is "transient." The EBA’s "5-Year Cap" The 2026 EBA report reaffirms the 5-year cap on the average repricing maturity for NMDs. While some banks argued for longer durations based on historical data, the EBA has imposed this limit as a prudential safeguard. Implementation Strategy: Segmentation: Banks must segment deposits into categories (retail vs. wholesale, operational vs. non-operational). Pass-through Rates: The speed at which a bank adjusts deposit rates in response to market moves is crucial. Lower pass-through rates generally justify longer durations, but under the new EBA scrutiny, these must be backed by at least 10 years of historical data. Core Balance Identification: Only the portion of deposits that is both stable in volume and insensitive to interest rate changes can be allocated to the longest maturity buckets. 3. EVE vs. NII: A Dual Perspective Modern IRRBB management requires a balanced approach between the "Economic Value" perspective and the "Earnings" perspective. Economic Value of Equity (EVE) EVE measures the long-term impact of rate changes on the present value of the bank’s balance sheet. The EBA SOT: Banks must calculate the impact of six sudden interest rate shocks. Discounting: Under the new guidelines, the inclusion of commercial margins in the discount curve is strictly regulated. The EBA prefers a risk-free rate approach for EVE to ensure comparability across the EU. Net Interest Income (NII) NII focuses on the short-to-medium term (usually a 1-to-3-year horizon). Dynamic Balance Sheet: Unlike EVE, which assumes a "run-off" or static balance sheet, NII modeling should ideally incorporate dynamic assumptions about future business growth and changes in the product mix. Sensitivity: The EBA 2026 report highlights that NII is currently more sensitive to "parallel down" scenarios, as banks face the "zero lower bound" on deposit rates while their assets reprice downward. 4. Credit Spread Risk in the Banking Book (CSRBB) One of the most significant shifts in the EBA’s 2024-2026 roadmap is the formalized treatment of CSRBB. This is the risk driven by changes in market perception of credit quality that are not captured by IRRBB or by idiosyncratic credit risk. Key Requirements: Scope: Banks can no longer ignore CSRBB on assets held at amortized cost if they are sensitive to market spread moves. Modeling: The EBA demands consistency. If a bank includes credit spreads in its internal risk management, it must also reflect them in its Pillar 3 disclosures. Identification: Institutions must clearly distinguish between the "liquidity component" and the "credit component" of the spread. 5. Integrating IRRBB into the Technology Stack (SAP and Beyond) The complexity of these requirements necessitates an integrated approach to data. Manual spreadsheets are no longer sufficient to meet EBA reporting standards. Data Granularity A robust ALM (Asset and Liability Management) system must be able to ingest contract-level data. This includes: Optionality (prepayment caps, floors). Behavioral curves for NMDs. Detailed margin components. Scenario Analysis and Stress Testing The system must be capable of running the six EBA-mandated scenarios (Parallel Up/Down, Steepener, Flattener, Short Rates Up/Down) almost instantaneously. Furthermore, "Reverse Stress Testing" is now a requirement: banks must identify which interest rate path would lead to a breach of their solvency requirements. 6. Commercial Margins and Behavioral Assumptions The EBA has noted a lack of uniformity in how commercial margins are treated in EVE calculations. The Integrated Approach: Constant Spread Assumption: The default supervisor expectation is that commercial spreads remain constant over the life of the instrument. Prepayment Risk (CPRs): Conditional Prepayment Rates must be modeled as a function of the interest rate environment. In a "rates down" scenario, prepayment speeds increase, shortening the duration of assets and creating a "negative convexity" that must be managed through hedging. 7. Hedging Strategies in the New Environment With the EBA’s focus on the effectiveness of hedging, the use of derivatives (Swaps, Caps, Floors) must be tightly linked to the underlying risks. Macro Hedging: Used to manage the overall duration of the balance sheet. Micro Hedging: Target specific portfolios or large exposures. Accounting Consistency: The EBA encourages banks to ensure that their risk management hedges are reflected correctly in their hedge accounting (IFRS 9), reducing P&L volatility. 8. Governance and Pillar 3 Disclosures Transparency is the final pillar of the EBA’s strategy. The 2026 report emphasizes that the "Internal Management Framework" (IMS) must be approved by the Board of Directors. Disclosure Requirements: Detailed explanation of NMD modeling assumptions. Disclosure of the average repricing maturity of deposits. Impact of the 5-year cap on the bank’s reported risk metrics. 9. Conclusion: The Path Forward The EBA’s 2026 report on the IRRBB Heatmap makes it clear: the era of "simplistic modeling" is over. Institutions must now demonstrate a deep understanding of their balance sheet's behavioral nuances. By integrating advanced behavioral models (for NMDs and prepayments) with a dual EVE/NII perspective and a formalized CSRBB framework, banks can move beyond mere compliance. A sophisticated IRRBB framework allows a bank to optimize its capital allocation, protect its net interest margin, and ultimately create a competitive advantage in an uncertain interest rate environment. The key to success lies in the synergy between Regulatory Intelligence (understanding EBA mandates), Quantitative Modeling (NMD and CSRBB math), and Technological Infrastructure (robust ALM systems). Only through this three-pronged approach can a modern bank navigate the complexities of interest rate risk in the coming decade. 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

Capital Optimization is the New Weapon: Why Finance and Operations Must Converge Now

The End of Abundant Liquidity — and the Beginning of Capital Scarcity The global economy has crossed a structural point of no return. The era of cheap, abundant liquidity—supported by low interest rates, synchronized globalization, stable supply chains, and benign inflation—has definitively ended. What replaces it is not a temporary downturn, but a new operating regime defined by: Persistent inflationary pressure Geopolitical fragmentation Supply chain reconfiguration Regulatory intensification A structurally higher cost of capital In this environment, capital is no longer a passive balance-sheet outcome or a regulatory constraint. Capital has become a competitive weapon. How efficiently an enterprise prices, protects, deploys, and releases capital now determines: Its ability to invest Its operational resilience Its tolerance to shocks Its long-term profitability Capital optimization—once a specialized treasury concern—has evolved into a multidimensional, enterprise-wide capability. Risk, finance, supply chain, procurement, regulatory reporting, sustainability, and contract management are no longer independent disciplines. They now converge around a single strategic concept: Capital Intelligence. SAP as the Enabler of the Capital-Aware Enterprise This convergence has only become feasible because of SAP’s real-time, event-driven architecture. Through solutions such as: SAP Financial Products Subledger (FPSL) SAP Intelligent Financial Risk Analytics (IFRA) SAP Analytics Cloud SAP Integrated Business Planning (IBP) SAP Characteristics-Based Planning (CBP) SAP Financial Reporting Data Platform (FRDP) Integrated collateral and treasury engines SAP enables capital strategy to be embedded directly into operational execution. The result is a new operating paradigm: the capital-aware enterprise—capable of sensing disruption early, simulating outcomes dynamically, and acting with precision to reduce capital drag, accelerate liquidity, and shape profitability in real time. I. Regulatory Convergence: Where IFRS 9 Meets Basel IV IFRS 9 and Basel IV were designed with a common objective: aligning capital consumption with economic risk. Yet in most institutions, they still operate as parallel universes. Data duplication Redundant calculations Long reconciliation cycles Structural inconsistencies between risk and finance The result is predictable: capital inefficiency and management blind spots. When IFRS 9 and Basel IV derive from the same architecture, regulation stops being a burden and starts being strategic intelligence. FPSL Changes the Equation SAP FPSL introduces a unified financial and risk subledger with: Transaction-level granularity Multi-GAAP coexistence Event-driven, real-time accounting Native integration of PD, LGD, and EAD Seamless alignment between ECL and RWA When IFRS 9 provisioning and Basel IV capital consumption are derived from the same data architecture, institutions can finally calculate the true marginal economic cost of credit at instrument level. At that point, regulation stops being a compliance burden—and becomes strategic intelligence. II. Dynamic Collateral: From Recordkeeping to Capital Engineering Collateral remains one of the most underutilized levers of capital efficiency. Historically, collateral has been treated as static metadata: Captured at origination Rarely revalued Weakly linked to provisioning logic This leads to overstated LGDs, excessive provisions, and trapped capital. FPSL + SAP Collateral Management = Active Capital Release When FPSL is integrated with SAP’s collateral engines and IFRA, collateral becomes a live optimization variable: Real-time valuation Basel eligibility tracking Legal enforceability scoring Automated LGD recalibration Algorithmic capital release Scenario overlays and stress testing transform collateral from an administrative record into a capital control mechanism. The impact is immediate: Lower provisions Stronger capital ratios Faster decision cycles III. Autonomous Supply Chains: Inventory as Capital Capital optimization is not confined to banks. In manufacturing, energy, chemicals, and industrial distribution, the largest consumer of capital is inventory. Excess safety stock, long cycle times, planning silos, and demand volatility have pushed organizations to buffer uncertainty with capital-intensive inventory. From Automated to Capital-Intelligent Supply Chains SAP Characteristics-Based Planning (CBP) redefines planning logic: Forecasting by attributes instead of SKUs Segmenting inventory by cost, margin, volatility, and risk Treating inventory as a financial asset SAP IBP extends this into predictive scenario modeling across sourcing, capacity, and portfolio structure. The result: Inventory reduction without service degradation Accelerated cash cycles Financially aware planning Strategic capital deployment This is the autonomous supply chain—not just automated, but capital-intelligent. Inventory is not just stock; it is capital in physical form. A capital-intelligent supply chain is the next frontier of profitability. IV. Contract Intelligence: Capital Risk Moves into Legal Text Contracts have become direct capital risk vectors. Pricing clauses, collateral triggers, ESG obligations, operational resilience requirements, and regulatory exposure are now embedded in contractual language. SAP Ariba Contracts, enhanced with AI and RegTech logic, transforms contracts into active capital surfaces: Real-time clause validation Supplier and counterparty risk scoring Dynamic price and collateral triggers KPI-driven exposure alerts Contracts evolve from static documents into living instruments of capital governance. V. Capital Projects as Financial Products Infrastructure, energy assets, and industrial platforms increasingly behave like financial instruments. Their lifecycle demands: Operational execution Multi-GAAP valuation Risk management Capital-market connectivity SAP enables this convergence through a closed-loop architecture: Project System (PS): Execution, milestones, cost control Investment Management (IM): Portfolio gating and capitalization FPSL: Valuation, accounting, and regulatory coexistence Treasury & Risk Management (TRM): Funding, hedging, investor logic Together, they transform projects into capital-efficient investment vehicles. VI. The Rise of the Capital Optimization Architect As finance, risk, operations, and data converge, a new professional role emerges: The Capital Optimization Architect This role is inherently multidisciplinary: Risk modeling ERP and data architecture Treasury and balance sheet strategy Supply chain finance Regulatory intelligence Their mission is not system implementation—but capital system design. Organizations that develop this capability achieve: Higher ROE Lower volatility Faster decisions Greater resilience Stronger innovation capacity VII. Conclusion: Capital Intelligence as Competitive Advantage Capital is no longer static. It moves with operational decisions, regulatory shifts, supply risk, contractual data, and market signals. Organizations that treat capital as a passive outcome will fall behind. Those that treat capital as a design variable will lead. SAP provides the infrastructure for this new reality: A unified intelligence ecosystem Shared data Shared analytics Shared decision logic In the post-liquidity era, competitive advantage belongs to enterprises that can sense, simulate, and respond continuously—not quarterly. Capital optimization is no longer a back-office function. It is the foundation of resilience, profitability, and growth. Strategic business value potential: 10/10. 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. #CapitalOptimization #FinancialIntelligence #S4HANA #CFOStrategy #SupplyChainFinance #BaselIV #DigitalTransformation #AssetLiabilityManagement #SAPIBP #CapitalIntelligence #EconomicResilience #FerranFrances