Dynamic deposit behaviours in IRRBB: Enhancing risk management through sensitivity analysis

Abstract

The banking industry is inherently exposed to interest rate risk, which arises from the mismatch between the interest rate sensitivities of assets and liabilities. This mismatch can lead to significant fluctuations in a bank’s net interest income (NII) and economic value of equity (EVE) when interest rates change. In recent years, dynamic deposit behaviours have emerged as a significant factor influencing interest rate risk in the banking book (IRRBB). Conventional asset liability management (ALM) models often overlook the evolving nature of deposit betas, product mixes and decay rates, resulting in suboptimal risk assessments. This paper advocates for integrating dynamic modelling approaches while acknowledging the importance of sensitivity analysis to bridge the gap between static and dynamic frameworks. By embedding these techniques into ALM practices, banks can improve IRRBB management, effectively balancing complexity and simplicity while better addressing depositor behaviour in fluctuating interest rate environments.