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Interest Rate Risk Management At Bank

INTEREST RATE RISK

The acceptance and management of financial risk is inherent to the business of banking and banks’ roles as financial intermediaries. To meet the demands of their customers and communities and to execute business strategies, banks make loans, purchase securities, and take deposits with different maturities and interest rates. These activities may leave a bank’s earnings and capital exposed to movements in interest rates. This exposure is interest rate risk.

Interest rate risk is the risk to earnings or capital arising from movement of interest rates. It arises from differences between the timing of rate changes and the timing of cash flows (repricing risk); from changing rate relationships among yield curves that affect bank activities (basis risk); from changing rate relationships across the spectrum of maturities(yield curve risk); and from interest-rate-related options embedded in bank products (option risk).

The evaluation of interest rate risk must consider the impact of complex, illiquid hedging strategies or products, and also the potential impact on fee income that is sensitive to changes in interest rates.

The movement of interest rates affects a bank’s reported earnings and book capital by changing:-

 Net interest income,
 The market value of trading accounts (and other instruments accounted for by market   value), and
 Other interest sensitive income and expenses, such as mortgage servicing fees.

Changes in interest rates also affect a bank’s underlying economic value. The value of a bank’s assets, liabilities, and interest-rate-related, off-balance-sheet contracts is affected by a change in rates because the present value of future cash flows, and in some cases the cash flows themselves, is changed.

SOURCES OF INTEREST RATE RISK:-

Repricing risk:

As financial intermediaries, banks encounter interest rate risk in several ways. The primary and most often discussed form of interest rate risk arises from...