Where did the standard 200bp shock come from (part 2)?
Originally published 3/02/2012 © 2021 Olson Research Associates, Inc.
To understand exactly when the 200bp shock seed was planted you have go back 19 years to September 1993. Some folks may not consider that the distant past but for me (it pre-dates the birth of both my kids but not my wedding day) it seems like a long time ago. I wanted to take a look at the wording in the Joint Policy Statement that described the proposed IRR supervisory model. That was easier said than done. Research for at least the past decade has been done mostly using the web. However, even the FDIC’s listing of FIL’s only goes back to 1995. Fortunately for me in the bottom drawer of an all-but-forgotten filing cabinet of my office was a 3-ring notebook that had a hand-written title page which said simply, “Interest rate risk”. The notebook contained a veritable goldmine of documents, articles, and studies on IRR from 1975-1995. One of those documents was the, “Risk-Based Capital Standards: Interest Rate Risk, Notice of Proposed Rule Making, JPS, 9/14/1993".” Bingo!
The study that Mr. Matz was referring to was explained starting on page 22. The Fed did indeed examine the changes in rates over the period 1977 to 1992. They looked at both the nominal changes in rates and the proportional changes in rates. Specifically they were looking for the comments on the most appropriate volatility measure for assessing risk exposures:
…comments are sought on alternative methodologies for determining scenarios. The first alternative measures historical volatility using nominal basis point changes in market rates. For example, a change in the 6-month rate from 3.00% to 3.50% would be measured as a movement of 50 basis points, as would a change from 10.00% to 10.50%…
…a second alternative measures historical volatility as a proportion by which rate change. For example, the same increase from 3.00% to 3.50% would be measured as a movement of 16.6% of the initial rate whereas the increase from 10.00% to 10.50% would be measured as a change of 5.0%
…possible interest rate scenarios using both alternative methods and quarterly and annual time horizons are shown below:
Nominal Change Proportional Change
Maturity Quarterly Annual Quarterly Annual
0–3 months 115bp 320bp 100bp 190bp
3–12 months 120bp 300bp 100bp 190bp
1–3 years 130bp 250bp 110bp 210bp
3–5 years 125bp 200bp 115bp 235bp
5–10 years 110bp 170bp 110bp 235bp
10–20 years 100bp 140bp 110bp 235bp
Over 20 years 80bp 130bp 110bp 240bp
Surrounding the chart are paragraphs that describe the data and talk about how the relative steepness of the curve impacts the results. However it’s the following paragraph that is the most important:
Currently, the results under either proposed methodology indicate rate changes that are about 100 basis points using a quarterly time horizon and 200 basis points using annual volatilities. In the interest of simplicity, the banking Agencies also seek comment on the use of a parallel 100 or 200 basis point shift. For purposes of this rule-making, a simple 200 basis point shift is illustrated in the proposed amendments…
There it is in black and white. Granted the document doesn’t explicitly say, “use 200bp.” But remember this was 1993 - just following the S&L crisis. It was pretty clear that leverage and IRR were a big part of the problem. Measuring IRR was a pretty new concept to most bankers and regulators. I’m not surprised that people latched onto the suggestions outlined in a document that presents, “alternative methodologies for determining scenarios,” and provides some reasonable data to back it up.
(This post is part of a series which provides a basic overview and discussion of interest rate risk stress-testing.)