7.1 This chapter sets out the methodology the PRA uses to inform the setting of a firm’s Pillar 2A capital requirement for interest rate risk in the non-trading book, commonly known as interest rate risk in the banking book (IRRBB).

Definition of scope of application

7.2 IRRBB is the risk of losses arising from changes in the interest rates associated with banking book items.

7.3 For larger or more complex firms the PRA employs a comprehensive approach to its IRRBB risk assessment that reviews duration risk, basis risk and, as necessary, optionality risk.

• Duration risk arises when the re-pricing of banking products (assets and liabilities) is mismatched across time buckets. Firms generate these positions via the normal running of their banking book and manage the resultant risks through their internal management processes and hedging activities.

• Basis risk is generated by banking book items that re-price in relation to different reference rates. The most common and material basis risks seen within UK banks derive from products re-pricing against policy rates (eg Bank Rate) and market rates (eg SONIA). As part of the review of basis risk the PRA also considers asset swap spread risk, which typically arises when firms hedge the duration risk associated with fixed rate securities using derivatives (typically interest rate swaps).