10 Steps to Assess Your Bank's Risk of Economic Value of Equity (EVE) Mismanagement

Recent events surrounding the collapse of SVB have sparked concern about banks effectively managing their economic value of equity (EVE). As a result, many may be wondering if their bank is similarly at risk.

To ensure that your bank is managing its economic value of equity (EVE) effectively, consider these ten steps:

1) Review your current and historical EVE results to determine your exposure to interest rate fluctuations. Is your institution exposed to interest rates increasing or decreasing?

2) Assess the significance of your EVE exposure each month and ensure that you're staying within a reasonable trigger or limit.

3) Operating under EBA guidelines provides an additional level of protection against economic value risk. Non-parallel shocks can be used to identify asset and liability positions that may provide an "offset" for parallel shocks but are actually at different points on the repricing gap. For example, an asset in a 5-year bucket may be offsetting a much larger liability position in a 1-year bucket. By examining non-parallel shocks, you can gain a more comprehensive understanding of your bank's economic value risk exposure and take appropriate steps to manage it.

4) Check for open asset/liability positions in your repricing gap. Large open positions offset by large open liabilities in buckets that are close to each other are not typically a cause for concern. However, if you have many small open positions going in the same direction without offsets, add up the smaller positions to ensure they don't pose a substantial risk.

5) Evaluate your assumptions. While your repricing gap may appear fine, assumptions can make open positions look smaller than they are. It's crucial to assess what is going into each bucket and ensure that assumptions are realistic.

6) When offsetting fixed assets with current account assumptions, ensure that the account balances will remain the same and that the interest rate won't change for the next five years if it's being used to offset five-year mortgages, for example.

7) Be cautious when using reserve spreading assumptions to offset fixed asset positions with capital. In situations like SVB's collapse, a decrease in the asset portfolio's value won't be matched by an increase in equity's value. As a result, reserve spreading assumptions may not hedge the underlying interest rate risk effectively. Ensure that this approach aligns with your institution's risk appetite.

8) Assess any other assumptions that may be impacting your results. Obtain a breakdown of your contractual repricing gap and EVE results, and evaluate the appropriateness of assumptions that may be masking open positions. Determine the maximum exposure to interest rates increasing when you strip out these assumptions.

9) Evaluate the treasury team's understanding and priority of managing IRRBB. Determine if they focus solely on NII, understand EVE, and discuss swap rates going up and down. If necessary, dive deeper into their understanding to ensure they're effectively managing risk.

10) Assess your institution's risk appetite by reviewing the IRR policy for any areas that may cause concern.

To ensure that your bank is not at risk of EVE mismanagement, like SVB, it's essential to review your current and historical EVE results, assess your exposure to interest rate fluctuations, and operate under EBA guidelines. Additionally, it's important to evaluate your assumptions, check for open asset/liability positions in your repricing gap, and be cautious when using reserve spreading assumptions. Lastly, assessing your treasury team's understanding and priority of managing IRRBB and reviewing your institution's risk appetite can further help you mitigate the risk of EVE mismanagement. By taking these measures, you can better manage economic value risk at your bank and minimise the risk of mismanagement.