Market Evidence on the Effective Maturity of Bank Assets and Liabilities

Abstract

THE RECENT YEARS' increase in interest rate volatility has intensified concern over the exposure of commercial banks to interest rate or funding risk. Since the effect of interest rate changes on the equity value of a bank depends on the or duration of the bank's assets and liabilities, assessing an individual bank's interest rate risk exposure requires information about the composition of its portfolio. It is difficult, however, to assess a bank's risk exposure from balance sheet data because several important asset and liability items have theoretically ambiguous maturities. In a frictionless market, a security's will equal its stated (or time to repricing). With market imperfections (e.g., depositors' transaction or information costs), however, the equilibrium cost of some deposit items may respond sluggishly or incompletely to market rate changes (see Hester and Pierce 1975 or Flannery 1982). Such liabilities' market values (discounted at market rates) would therefore fluctuate with the level of interest rates. These liabilities are sometimes called core deposits, which manifest sticky responses to market rate changes. We define an asset or liability's effective maturity as the of a fixed rate, perfectly elastically supplied security with the same market-value elasticity as the bank balance sheet item under consideration. Naturally, a balance sheet item's is the relevant determinant of its contribution to the bank's overall interest rate risk sensitivity.