CAIIB-ABM-MOD-D-Interest Rate Risk Management

Interest Rate Risk Management

• Interest rate risk is the exposure of a bank's financial condition to adverse movements in interest rates.

• Gap: The gap is the difference between the amount of assets and liabilities on which the interest rates are reset during a given period.

• Interest rate risk refers to volatility in Net Interest Income (NiI) or in variations in Net Interest Margin (NIM)

• The degree of basis risk is fairly high in respect of banks that create composite assets out of composite liabilities.

• The risk that the interest rate of different assets and liabilities may change in different magnitudes is called basis risk.

• When assets and liabilities fall due to repricing in different periods, they can create a mismatch. Such a mismatch or gap may lead to gain or loss depending upon how interest rate in the market tend to move.

• The degree of basis risk is fairly high in respect of banks that create composite assets out of composite liabilities

• When the variation in market interest rate causes the Nil to expand, the banks have experienced a favourable basis shift and if the interest rate movement causes the Nil to contract, the basis has moved against the bank.

• An yield curve is a line on a graph plotting the yield of all maturities of a particular instrument

• Price risk occurs when assets are sold before their maturity dates.

• The price risk is closely associated with the trading book which is created for making profit out of short-term movements in interest rates.

• Uncertainty with regard to interest rate at which the future cash flows can be reinvested is called reinvestment risk.

• When the interest rate goes up, the bonds price decreases

• When the interest rate declines the bond price increases resulting in a capital gain but the realised compound yield decreases because of lower coupon reinvestment income.

• Duration is a measure of the percentage change in the economic value of a position that will occur, given a small change in the level of interest rates.

• Higher duration implies that a given change in the level of interest rates will have a larger impact on economic value.

• Interest Rate Sensitive Gap: Interest Rate Sensitive Assets(RSA) - Interest Rate Sensitive Liabilities (RSL).
  
  
• Positive Gap or Asset Sensitive Gap - RSA - RSL > 0 & Negative Gap or Liability Sensitive - RSA - RSL < 0

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