Nontrading market risk arises primarily from outside the activities of our trading units, in our banking book and from certain off-balance sheet items. Significant market risk factors the Group is exposed to and are overseen by risk management groups in that area are:
- Interest rate risk (including risk from embedded optionality and changes in behavioral patterns for certain product types), credit spread risk, foreign exchange risk, equity risk (including investments in public and private equity as well as real estate, infrastructure and fund assets).
- Market risks from off-balance sheet items such as pension schemes and guarantees as well as structural foreign exchange risk and equity compensation risk.
Interest Rate Risk in the Banking Book
Interest rate risk in the banking book is the current or prospective risk, to both the Group's capital and earnings, arising from movements in interest rates, which affect the Group's banking book exposures. This includes gap risk, which arises from the term structure of banking book instruments, basis risk, which describes the impact of relative changes in interest rates for financial instruments that are priced using different interest rate curves, as well as option risk, which arises from option derivative positions or from optional elements embedded in financial instruments.
The Group manages its IRRBB exposures using economic value as well as earnings based measures. Our Group Treasury division is mandated to manage the interest rate risk centrally on a fiduciary basis, with Market Risk Management acting as an independent oversight function.
Economic value based measures look at the change in economic value of banking book of assets, liabilities and off-balance sheet exposures resulting from interest rate movements, independent of the accounting treatment. Thereby the Group measures the change in Economic Value of Equity (“∆EVE”) as the maximum decrease of the banking book economic value under the 6 standard scenarios defined by Basel Committee on Banking Supervision (BCBS).
Earnings-based measures look at the expected change in Net Interest Income (“NII”), compared to a defined benchmark scenario, over a defined time horizon resulting from interest rate movements. Thereby the Group measures ∆NII as the maximum reduction in NII under the 6 standard scenarios defined by Basel Committee on Banking Supervision (BCBS), compared to the Group’s official capital planning, over a period of 12 months.
The Group employs mitigation techniques to immunize the interest rate risk arising from nontrading positions. The majority of our interest rate risk arising from nontrading asset and liability positions are managed through Treasury Pool Management. Treasury Pool Management hedges the transferred net banking book risk with Deutsche Bank’s trading books within the CIB division. The treatment of interest rate risk in our trading portfolios and the application of the value-at-risk model is discussed in the “Trading Market Risk” section of this document.
The Global Model Validation and Governance group performs independent validation of models used for IRRBB measurement in line with Deutsche Bank’s group-wide risk governance framework.
The most notable exceptions from the aforementioned paragraphs are in some Private & Commercial Bank (“PCB”) entities (e.g. Postbank). These entities manage interest rate risk through their entity specific Asset and Liability Management departments.
The measurement and reporting of economic value interest rate risk is performed daily, and earnings risk is monitored on a monthly basis. The Group generally uses the same metrics in its internal management systems as it applies for the disclosure in this report. This is applicable to both the methodology as well as the modelling assumptions used when calculating the metrics. The only notable exception is the usage of a steady (i.e. unchanged) rates scenario as benchmark for the ∆NII calculation in the public disclosures, whereas the internal quantitative risk appetite metric will use the Group’s official capital planning curve.
Deutsche Bank’s key modelling assumptions are applied to the positions in our PCB division and parts of our CIB Division. Those positions are subject to risk of changes in our client’s behavior with regard to their deposits as well as loan products.
The Group manages the interest rate risk exposure of its Non-Maturity Deposits (NMDs) through a replicating portfolio approach to determine the average repricing maturity of the portfolio. For the purpose of constructing the replicating portfolio, the portfolio of NMDs is clustered by dimensions such as Business Unit, Currency, Product and Geographical Location. The main dimensions influencing the repricing maturity are elasticity of deposit rates to market interest rates, volatility of deposit balances and observable client behavior. For the reporting period the average repricing maturity assigned across all such replicating portfolio is 1.6 years and Deutsche Bank uses 15 years as the longest repricing maturity.
In the Loan and some of the Term deposit products Deutsche Bank considers early prepayment/withdrawal behavior of its customers. The parameters are based on historical observations, statistical analyses and expert assessments.
Furthermore, the Group generally calculates IRRBB related metrics in contractual currencies and aggregates the resulting metrics for reporting purposes. When calculating economic value based metrics without the exclusion of the commercial margin, the appropriate yield curve is selected that represents the characteristics of the instrument concerned.
Credit Spread Risk in the Banking Book
Deutsche Bank is exposed to credit spread risk of bonds held in the banking book, mainly as part of the Treasury Liquidity Reserves portfolio and in Postbank. This risk category is closely associated with interest rate risk in the banking book as changes in the perceived credit quality of individual instruments may result in fluctuations in spreads relative to underlying interest rates.
Foreign Exchange Risk
Foreign exchange risk arises from our nontrading asset and liability positions that are denominated in currencies other than the functional currency of the respective entity. The majority of this foreign exchange risk is transferred through internal hedges to trading books within Corporate & Investment Bank and is therefore reflected and managed via the value-at-risk figures in the trading books. The remaining foreign exchange risks that have not been transferred are mitigated through match funding the investment in the same currency, so that only residual risk remains in the portfolios. Small exceptions to above approach follow the general Market Risk Management monitoring and reporting process, as outlined for the trading portfolio.
The bulk of nontrading foreign exchange risk is related to unhedged structural foreign exchange exposure, mainly in our U.S., U.K. and China entities. Structural foreign exchange exposure arises from local capital (including retained earnings) held in the Group’s consolidated subsidiaries and branches and from investments accounted for at equity. Change in foreign exchange rates of the underlying functional currencies are booked as Currency Translation Adjustments ("CTA").
The primary objective for managing our structural foreign exchange exposure is to stabilize consolidated capital ratios from the effects of fluctuations in exchange rates. Therefore the exposure remains unhedged for a number of core currencies with considerable amounts of risk-weighted assets denominated in that currency in order to avoid volatility in the capital ratio for the specific entity and the Group as a whole.
Equity and Investment Risk
Nontrading equity risk arising predominantly from our non-consolidated investment holdings in the banking book and from our equity compensation plans.
Our non-consolidated investment holdings in the banking book are categorized into strategic and alternative investment assets. Strategic investments typically relate to acquisitions made to support our business franchise and are undertaken with a medium to long-term investment horizon. Alternative assets are comprised of principal investments and other non-strategic investment assets. Principal investments are direct investments in private equity (including leveraged buy-out fund commitments and equity bridge commitments), real estate (including mezzanine debt) and venture capital, undertaken for capital appreciation. In addition, principal investments are made in hedge funds and mutual funds in order to establish a track record for sale to external clients. Other non-strategic investment assets comprise assets recovered in the workout of distressed positions or other legacy investment assets in private equity and real estate of a non-strategic nature.
We are exposed to market risk from a number of defined benefit pension schemes for past and current employees. The ability of the pension schemes to meet the projected pension payments is maintained through investments and ongoing plan contributions. Market risk materializes due to a potential decline in the market value of the assets or an increase in the liability of each of the pension plans. Market Risk Management monitors and reports all market risks both on the asset and liability side of our defined benefit pension plans including interest rate risk, inflation risk, credit spread risk, equity risk and longevity risk. For details on our defined benefit pension obligation see additional Note 36 .
Market risks in our asset management activities in Deutsche Asset Management, primarily results from principal guaranteed funds or accounts, but also from co-investments in our funds.