Definition
EVE (economic value of equity) is the net present value of all interest-rate-sensitive future cash flows in the banking book: assets, liabilities and off-balance-sheet items. It measures the economic value of equity, the value attributable to shareholders, independently of accounting conventions.
What banks and supervisors monitor is not the level of EVE but its change, ΔEVE: the difference between the present value on the reference curve and the present value on a shocked curve. A negative ΔEVE means that a rate move destroys economic value.
Calculation method
The calculation follows four steps:
- project principal and interest cash flows for each banking book position, using contractual schedules and behavioural assumptions (non-maturity deposits, prepayments);
- discount these cash flows on the reference curve, by currency;
- discount the same cash flows on each shocked curve, applying the regulatory post-shock rate floor;
- compute ΔEVE = shocked present value − reference present value, then aggregate currencies according to the regulatory rules.
Own funds instruments are excluded. Options, whether automatic or behavioural, must be valued consistently with each scenario.
Regulatory requirement
The Basel Committee IRRBB standards (2016), transposed in the CRD and specified by the EBA guidelines (EBA/GL/2022/14), require EVE to be measured under six supervisory shock scenarios: parallel up, parallel down, steepener, flattener, short rates up and short rates down. Shock sizes are set by currency.
The supervisory outlier test compares the worst EVE decline with Tier 1 capital: beyond 15% of Tier 1, the supervisor may require measures. Results are reported in the EBA IRRBB templates (ITS) and feed the ICAAP.
Practical challenges
Three points concentrate the ALM team's effort:
- behavioural assumptions, which drive liability duration and must be documented and justified;
- explaining changes between reporting dates: rate, volume and time effects and assumption changes, isolated for the committee;
- volume and reproducibility: six scenarios, several currencies and entities, recomputed at every reporting date and for every variant.
In RIALTO
This concept is covered by the IRRBB Insight Core module. The use case 'Explaining a change between two reporting dates' shows it in practice.