IRRBB: EVE vs NII Sensitivity in Practice

Interest-rate risk in the banking book (IRRBB) is one of those disciplines that looks simple on a slide and gets uncomfortable the moment you run real numbers on a real balance sheet. Two headline metrics — Economic Value of Equity (EVE) and Net Interest Income (NII) sensitivity — do most of the reporting work. They answer different questions and, more importantly, they fail in different ways.

EVE: the balance-sheet view

EVE takes today's balance sheet, discounts every future cash flow at a shifted curve, and asks: what happens to the present value of equity? It is a long-horizon, mark-to-model view. Regulators use it because it captures duration mismatches that NII can hide — a long-fixed asset book funded by short deposits looks fine on next year's income until rates jump.

The Basel supervisory outlier test compares the worst-case EVE loss across six prescribed rate shocks against 15% of Tier 1 capital. Breaching it triggers supervisory attention. The mechanics are simple; the modelling choices behind them are not.

NII: the earnings view

NII sensitivity projects net interest income over a shorter horizon (typically 12 months, sometimes up to 3–5 years) under the same shocked curves. It is what the CFO and ALCO actually run the business on. NII is more intuitive, easier to explain to a non-technical board, and it directly ties to guidance and dividend capacity.

But NII sensitivity is quiet on anything that repices past the horizon. A 10-year fixed mortgage funded by a 3-month deposit will show up loudly in EVE and barely at all in a 1-year NII sensitivity — until the deposit reprices in year two.

Where the numbers come from — and where they lie

Both metrics share the same three modelling headaches:

1. Non-maturity deposits (NMDs). Current accounts have no contractual repricing date. Every bank models them differently, and the assumption chosen — how much is core, how slowly it reprices, how long it stays sticky — often drives the EVE result more than the actual asset book does. This is the single most common finding in IRRBB validations.
2. Prepayments and early redemptions. Behavioural models on mortgages, term deposits, and loans have to move with rates. Static prepayment assumptions in a rate-shock scenario are indefensible.
3. Basis and optionality. EVE built on a single risk-free curve ignores basis between funding curves and asset yields. Cap-and-floor structures on retail products create nonlinear payoffs that a parallel shock hides.

Making the two metrics work together

A useful IRRBB framework does three things:

• Runs EVE and NII on the same underlying cash flows. If the two metrics use different behavioural assumptions, the numbers stop being comparable and ALCO stops trusting either one.
• Reports EVE alongside a 3-to-5-year NII projection. A single 12-month NII window will miss most of what EVE is telling you. Extending the earnings view is the cleanest bridge.
• Ties every scenario to a management action. A stress result with no pre-agreed response is a slide, not a limit. Hedging thresholds, deposit-pricing triggers, and reinvestment tilts should be documented before the number is breached, not after.

The regulatory backdrop

The 2018 BCBS IRRBB standards, EBA guidelines, and PRA SS31/15 all push in the same direction: banks must run both EVE and NII, disclose the six standard shocks, justify their behavioural assumptions, and integrate IRRBB into ICAAP. Since 2022, the EBA has tightened the supervisory outlier tests and added a specific NII outlier test — so NII is no longer just a management-information metric, it's a supervisory one too.

The practical takeaway

EVE tells you whether the balance sheet has the wrong duration. NII tells you whether next year's earnings can absorb a rate move. Neither is complete on its own. The most common failure mode is treating them as substitutes; the most common validation finding is that behavioural assumptions can't be defended when the auditor asks why exactly this number?

Get the behavioural assumptions documented, run both metrics off the same cash-flow engine, extend the NII horizon, and pre-agree the management actions. That is what turns IRRBB from a regulatory tick-box into a genuine ALM discipline.