IRR Bank Final
-
Upload
smit-parikh -
Category
Documents
-
view
218 -
download
0
Transcript of IRR Bank Final
-
8/8/2019 IRR Bank Final
1/29
Management ofInterest Rate Risk in Banks
-
8/8/2019 IRR Bank Final
2/29
Interest Rate Risk (IRR)
Definition:It is the potential loss from unexpected changes in
interest rates which can significantly alter a banks
profitability and market value of equity
-
8/8/2019 IRR Bank Final
3/29
Interest Rate Risk .. explained
The amount at risk is a function of the magnitude and direction
of interest rate changes and the size and maturity structure of the
mismatch position
If interest rates rise, the cost of funds increases more rapidly
than the yield on assets, thereby reducing net income. If the
exposure is not managed properly it can erode both the
profitability and shareholder value.
-
8/8/2019 IRR Bank Final
4/29
Interest Rate Risks - Types
Interest Rate Risks
Yie ERepricing Risk Basis Risk Risk Option Risk
Interest Rate
Risk
Re-pricing
Risk
Basis
Risk
Yield
Risk
EmbeddedOption
Risk
-
8/8/2019 IRR Bank Final
5/29
Repricing Risk
Arises on account of mismatches in rates Can be measured by the measure of risk in different time buckets Information needed
- Balance sheet- On & off on a particular day
- Business plan & expected income / expenses ignored- Static vs. Dynamic
Liabilities Assets Spread
Capital @ ROI Maturity Investment @ Maturity
(Crore)(Crore) ROIScenario-1 ProfitRs100 9% One year Rs100 10% Two year 1%(1crore)
Scenario-2 LossRs100 11% 2nd year Rs100 10% Two year 1%(1crore)
-
8/8/2019 IRR Bank Final
6/29
Basis Risk
Interest rates on assets and liabilities do not change in the sameproportion.
When Bank Rate was raised by 2%, PLR was raised by 1% and
deposit rates by 1.5%
Interest rates movement is based on market perception of risk andalso market imperfections.
Therefore, basis risk arises when interest rates of different assetsand liabilities change in different magnitudes.
The `basis form of IRR results from the imperfect correlationbetween interest adjustments when linked to different index ratesdespite having the same re-pricing characteristics.
-
8/8/2019 IRR Bank Final
7/29
Basis Risk - An Illustration
Repricing Liabilities (Rs Crores) Repricing Assets(Rs Crores)
Savings Deposit 50 Call Money 50
Fixed Deposit 50 Cash Credit 40
Total 100 Total 90
Gap(-) 10
Calculation of Standardised Gap Fall in Rates Fall in Amount
(Rs Crores)
Call Money 50 * 1.0% 0.50
Cash Credit 40 * 0.7% 0.28
A. Decrease in Interest Income (-) 0.78
Savings Deposit 50 * 0.5% 0.25
Fixed Deposit 50 * 0.4% 0.20
B. Decrease in Interest Expense (+) 0.45
Loss in Net Interest Income (A-B) (-) 0.33(Rs 33 Crores)
-
8/8/2019 IRR Bank Final
8/29
Embedded Option Risk
Risks arising out of prepayment of loans and bonds (with put orcall options) and / or premature withdrawal of deposits beforetheir stated maturity dates
Liabilities Assets Spread
Capital @ Maturity Loan @ ROI Maturity
(Crore) ROI (Crore)
Scenario-1 90 90 ProfitRs100 8% days Rs100 10% days 2%(0.49crore)
Scenario-2 90 90 2%(0.164crore)Rs100 for 30days8% days Rs100 10% days
Int. Rates 60 1%(0.164crore)for 60 daysdecline after days
30 days to 9%
Total 0.328 crore
-
8/8/2019 IRR Bank Final
9/29
Yield Curve Risk
Risks caused due to the change in the yield curve from
time to time depending on the repricing and various other
factors
Yield Curve is the relation between the interest rate (or
cost of borrowing) and the time to maturity of the debt for
a given borrower in a given currency.
-
8/8/2019 IRR Bank Final
10/29
Yield Curve Risk - An Illustration
Liabilities Assets Spread
Capital @ ROI Maturity Loan @ ROI Maturity
(Crore) (Crore)
Scenario-1 3 year Loan 3 year ProfitRs100 fixed(quar13.5% Rs100 16% float(qua 2.5%
Reference: terly Reference: rterly (2.5crore)91 day T-Bill repriced) 364 day T-Bill @13% repriced)@12.5%
Scenario-2 90 90 ProfitRs100 15% days Rs100 16% days 1.0%Reference: Reference: (1crore)91 day T-Bill 364 day T-Bill @13%
@14%
Date 91 T-Bill Deposit 364 T-Bill Loan Spread
22.05.2008 4.48% 5.48% 4.62% 7.62% 2.14%
08.08.2008 4.93% 5.93% 4.85% 7.85% 1.92%
08.12.2008 4.71% 5.71% 4.24% 7.24% 1.53%
-
8/8/2019 IRR Bank Final
11/29
Interest Rate Risks - Measurement
Interest Rate Risks
Yie ERepricing Risk Basis RiskRisk Option Risk
Approachesto Measure
IRR
Maturity Gap
Analysis
Duration Gap
Analysis
Simulation
-
8/8/2019 IRR Bank Final
12/29
Maturity Gap Analysis
MGA distributes
interest rate sensitive
assets, liabilities and OBS
positions into a certain
number of predefined timebands according to their
maturity(if fixed rate) or
time remaining to their next
repricing(if floating rate)
-
8/8/2019 IRR Bank Final
13/29
Maturity Gap Analysis ..
How is it done?The risk sensitive What is the Gap?
Objective: assets and riskThe gap is then
To improve the sensitive liabilities calculated bynet interest are grouped into considering the
income in the maturity buckets difference betweenshort run over based on maturity the absolute
discreet periods and the time until thevalues of the RSAs
of time called the first possible and RSLs.
gap periods. repricing due to RSG=RSAs-RSLschange in the interest
rates
Relative differences in each maturity bucket - represents the sensitivity in that
band.
-
8/8/2019 IRR Bank Final
14/29
Maturity Gap Method (IRS)
Three Options:
A) RSA>RSL= Positive Gap
B) RSL>RSA= Negative Gap
C) RSL=RSA= Zero Gap
-
8/8/2019 IRR Bank Final
15/29
Maturity Gap Analysis Option-1
Liabil Rate Increase Decreased Asset Rate Increase Decreased(Crores)ity % d Rate% % d Rate%
(Crores) Rate% Rate%
200 200
1800* 10 11 9 800* 12 13 11
3000 11 11 11 1000* 14 15 13
1000* 16 17 15
2000 18 18 18
5000 5000
Int 510 528 492Int 756 784 728
incomeExpe
nse
NII= 246 256 236
A case of Positive Gap:
RSAs= Rs2800, RSLs=Rs1800 GAP=Rs2800-RS1800=Rs1000
-
8/8/2019 IRR Bank Final
16/29
Maturity Gap Analysis Option-2
Liabil Rate Increase Decreased Asset Rate Increase Decreased(Crores)ity % d Rate% % d Rate%
(Crores) Rate% Rate%
200 200
1800* 10 11 9 800* 12 13 11
3000 11 11 11 1000 14 15 13
1000 16 17 15
2000 18 18 18
5000 5000
Int 510 528 492Int 756 784 728
incomeExpe
nse
NII= 246 256 236
A case of Negative Gap:
RSAs= Rs800, RSLs=Rs1800 GAP=Rs800-Rs1800=(-)Rs1000
-
8/8/2019 IRR Bank Final
17/29
Maturity Gap Analysis Option-3
Liabil Rate Increase Decreased Asset Rate Increase Decreased(Crores)ity % d Rate% % d Rate%
(Crores) Rate% Rate%
200 200
1800* 10 11 9 800* 12 13 11
3000 11 11 11 1000* 14 15 13
1000 16 17 15
2000 18 18 18
5000 5000
Int 510 528 492Int 756 784 728
incomeExpe
nse
NII= 246 256 236
A case of Zero Gap:
RSAs= Rs1800, RSLs=Rs1800 GAP=Rs1800-Rs1800=0
-
8/8/2019 IRR Bank Final
18/29
Inferences from above options:
SCENARIO STRATEGY
Maintain a positive gapRising Interest Rates
Declining InterestMaintain a Negative gapRates
Uncertain situationMaintain a Zero gap
(May not occur in reality)No benefits
-
8/8/2019 IRR Bank Final
19/29
Duration Gap Analysis
Duration Gap Analysis - What is it?
DurationDurationAnalysis:
DurationAnalysis:Duration is a Analysis:It concentratesmeasure of the It also measures
on the price riskpercentage the effect of rateand thechange in the fluctuation on
reinvestmenteconomic value the market valuerisk whileof a position that of the assets and
managing theoccurs given a liabilities andinterest ratesmall change in NIM with the helpexposure.level of interest of duration.
rate.
-
8/8/2019 IRR Bank Final
20/29
Duration Gap Analysis ..Illustration
Assets and Liabilities chart of Bharath Bank is presented here below along
with their durations and interest rates. Based on the information, identify the
RSG and the NIM. During the forecasting period of one year, if the interest ratesrise/fall by 2%, what would be its implication on the NIM of Bharath Bank?
Liabiliti Amount Duration Int. Rate Assets Amount Duration Int. Rate(months) (months)es (Crore) (%) (Crore) (%)
Equity Cash200 200
ST ST
Depo Loans1800 5.5 11.5 1800 2.75 12.5
LT LTDepo Loans2500 23.7 15 2000 23 16.5
Others Invest
ments500 11.5 11 1000 10.5 13.5
5000 5000
-
8/8/2019 IRR Bank Final
21/29
Duration Gap Analysis
Answer:RSG = RSAs - RSLs = (1800+1000) - (1800+500) = 500
AmountDurationInterest IncreasedDecreased Amount Duratio Interest Increased DecreasedLiabi Assetsnlities
(crore) in MnthsRate(%) Int. Int. (crore) in Rate(%) Int. Int.
Rate(%) Rate(%) Mnths Rate(%) Rate(%)
Equity 200 Cash 200STST
Depos 1800 5.5 11.5 13.5 9.5 Loans 1800 2.75 12.5 14.5 10.5
LTLTDepos 2500 23.7 15 15 15 Loans 2000 23 16.5 16.5 16.5
Others 500 11.5 11 13 9 Investm 1000 10.5 13.5 15.5 11.5
5000 5000Int. 637 683 591 Int 690 746 634Expe Income
NII 53 63 43NIM 0.010 0.0126 0.0086
6
-
8/8/2019 IRR Bank Final
22/29
Simulation
What is it? Data RequirementSimulates performance underalternative interest rate Maturity and repricingscenarios and assesses the Rate scenariosresulting volatility in NII / NIM Alternative management/ ROA / ROE / MVE
response under differentscenarios A financial modelYield curvesincorporating inter-Prepayment tablesrelationship of assets,
liabilities, prices, costs, Behavioural pattern of assets
volume, mix and other and liabilitiesbusiness related variables Consistency of assumptions
Computer generatedscenarios about future andresponse to that in a dynamicway
-
8/8/2019 IRR Bank Final
23/29
Simulation - Other information
Risk-Return policies - management appetite for risktaking
Regulatory framework - Ward against practices
which are considered unsafe and unsound
Capital strength and profitability
Experience and track record of management
Other risks embedded in the balance sheet -Liquidity / Credit / Forex risks
Business plan
-
8/8/2019 IRR Bank Final
24/29
Simulation
-Advantages -DisadvantagesForward looking
Accuracy depends on qualityDynamic
of data, strength of the model
and validity of assumptionsLessens the role of crisismanagement
Time consuming
Increases the value ofHuge investment in computer
strategic planning
Requires highly skilledEnhances capability of Personnelanalysis
Analysis paralysisInterpretation easy
Timing of cash flows capturedaccurately
-
8/8/2019 IRR Bank Final
25/29
Model
Deploy
Mo itorly e
ct
I tere t R te Ri k M geme t
-
8/8/2019 IRR Bank Final
26/29
Interest Rate Risk Management
* The ability of these types of models to capture this type of risk will vary with them
Interest Rate Risk Models
Risk Measurement Systems
GAP
Report
Earning
SimulationEconomic Valuation
Short-term earning exposure Yes Yes
Generally does not
distinguish short-term
accounting earnings from
changes in economic value
Long-term exposure Yes Limited* Yes
Repricing Risk Yes Yes YesBasis Risk Limited* Yes Limited*
Yield Curve Risk Limited* Yes Yes
Option Risk Limited* Limited* Yes
-
8/8/2019 IRR Bank Final
27/29
Benefits from IRR management
Defined financial targets based on corporate risktolerances
Reduced earnings volatility
Improved cash flow forecasting
Improved corporate credit ratings
Defined risk management and hedge methodologies
-
8/8/2019 IRR Bank Final
28/29
Based on the quantity of interest rate risk and quality of
interest rate risk management, we can evaluate the
adequacy of the banks capital
Determine the component rating for sensitivity to market
risk
Determine further the effect of interest rate and earningson the business in a macroscopic view
Conclusion
-
8/8/2019 IRR Bank Final
29/29
Questions? NOW