Interest rate risk supervision and bank capital management: What can the new prudential standards tell us?

The prudential regulation on interest rate risk in the banking book (IRRBB) is experiencing an important evolution following the publication of the new Basel Committee on Banking Supervision (BCBS) standards in 2016. Based on a sample of 30 small and medium size Italian commercial banks over the period 2006–2023, we examine the main regulatory innovations and the related criteria for determining the appropriate amount of internal capital to cover IRRBB. Our results show that the new rules are more prudential than past rules because they specifically remove some distorting effects, such as the risk neutrality phenomenon and can lead to a higher average measure of risk exposure. However, when compared to more sophisticated methodologies based on simulation techniques, the new rules lead to an ex-ante risk exposure that is less consistent with that actually observed ex post. Noteworthy implications in terms of a proper definition of internal capital to set aside against IRRBB are discussed.