Interest Rate Risk Exposure Research Articles

Lessons from the Collapse of Silicon Valley Bank

The Federal Reserve's consecutive interest rate hikes led to a decline in the prices of US Treasuries and mortgage-backed securities (MBS), which comprised a significant portion of Silicon Valley Bank (SVB)'s asset portfolio. As a result, SVB experienced substantial floating losses, exceeding its owner's equity, creating immense pressure on its assets and liabilities. The analysis also highlights the simple deposit and asset structures of SVB, with a high proportion of demand deposits and a significant allocation to bonds. The aggressive interest rate hikes by the Federal Reserve, coupled with financing difficulties for startups, accelerated deposit consumption and intensified debt pressure for SVB. Furthermore, the article reveals the low coverage rate of deposit insurance, particularly at SVB, where only 7% of deposits are insured. This adds to the vulnerability of SVB and its depositors. In conclusion, this article examines SVB's balance sheet and interest rate risk exposure, identifies shortcomings in the management supervision system, and provides three reflections on the financial event.

Measuring Interest Rate Risk Management by Financial Institutions

Financial intermediaries manage myriad interest rate risk exposures. We propose a new method to measure financial intermediaries' residual interest rate risk using high-frequency financial market data. Our method exploits all available high-frequency information and is valid under extremely weak assumptions. Applying the method to U.S. life insurers, we find their interest rate risk management strategies are generally effective. However, life insurers are more sensitive to changes in long-term interest rates than property and casualty insurers. We show that the term premium helps to explain the difference in sensitivities between the two types of insurer.

In Search of Habitat

Abstract We perform portfolio-level analyses to understand insurance firms’ preferred habitat behavior in the government bond market. Based on portfolio durations and portfolio weights across maturities, we find that interest rate risk exposures of insurers’ portfolios are related to their operating liabilities and financing constraints. We show that this habitat behavior significantly affects bond pricing. During the “quantitative easing” era, bond purchases by the Federal Reserve have a larger impact on the yields of Treasury bonds with a higher habitat demand. (JEL E43, E52, G11, G12, G23) Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Banks’ Management of Interest Rate Risk: Empirical Evidence from Savings Banks and Credit Cooperatives

Abstract German banking supervisors repeatedly warn of the potential threats arising from the current levels of interest rate risk. Especially banks with a traditional business model that highly depend on income from their interest business have extended their maturity transformation to stabilize the net interest margins with higher term premiums. This paper uses a unique data set comprising balance sheet data from German savings banks and credit cooperatives enhanced with information from their disclosure reports between 2012 and 2020 to analyze the level of interest rate risk and its management. The results suggest that interest rate derivatives are not primarily related to the general level of interest rate risk in banks but may particularly be used by banks to avoid exceeding specific regulatory limits. Furthermore, smaller banks are less likely to use derivatives. However, the results suggest that these banks manage their interest rate risk exposure via higher shares of securities, giving these banks more flexibility in maturity management.

Euro area banks' interest rate risk exposure to level, slope and curvature swings in the yield curve

We investigate the interest rate risk exposures of euro area banks during times of crises and very low interest rates. First, we assess sensitivities of banks' stock prices to changes in the level, slope and curvature of the yield curve using the Bayesian DCC M-GARCH model. Our findings reveal that stock price sensitivities change over time and that, on average, banks benefit from increases in the level, slope and curvature of the yield curve. Second, we observe that banks with higher capital ratios, more customer lending and less deposit financing are particularly sensitive to interest rate movements.

The Role of Maturity Gaps and Short-Term Market Interest Rates on Interest Rate Risk Exposure in Commercial Banks in Kenya

Commercial banks engage in maturity transformation and the term premium compensates them for bearing the associated duration risk. They are thus exposed to interest rate risk which is the bank's financial condition to adverse movements in interest rates and represents one of the key forms of risk that banks face as financial intermediaries. The study investigated the role of maturity gaps and short-term market interest rates on interest rate risk exposure in commercial banks in Kenya. This study adopted a panel data research design in methodology to analyze the critical interest rate risk drivers across the banking sector in Kenya. The study period covered 2005-2015. The study was informed by Expectations Hypothesis theory. Correlational research design was used and captured both cross-sectional and longitudinal dimensions of the effects of the variables under investigation that is Maturity gaps ratio (MGRs) and Interest Rate Sensitivity Ratio (IRSRs). The Interest rate risk (IRR) was expressed as a function of maturity gaps, interest rate sensitivity ratio and short-term market interest rates. STATA software was used as the tool for data manipulation. The findings indicated that that a rise in Maturity Gap 2, Maturity Gap 3, Maturity Gap 4, Maturity Gap 5, Interest Rate Sensitivity Ratio 2, Interest Rate Sensitivity Ratio 3, Interest Rate Sensitivity Ratio 4, 91DayTbill and 182DayTbill led to a decrease in the interest rate risk exposure for the commercial banks. However, an increase Maturity Gap 1, Interest Rate Sensitivity Ratio 1, Interest Rate Sensitivity Ratio 5 and 364DayTbill led to an increase in the interest rate risk exposure for the commercial banks. The study recommends that banks should have interest rate risk measurement frameworks that capture all material sources of interest rate risk and that measure the effect of interest rate changes in ways that are consistent with the scope of their activities. The assumptions underlying the system should be clearly understood by risk managers and bank management. Further, banks must establish and enforce operating limits and other practices that maintain exposures within levels consistent with their internal policies. The findings are important in formulation of policies and strategies for enhancing maturity transformation in the banking industry in the country. Keywords: Maturity Gap Ratio, Interest Rate Risk Sensitivity Ratio, Interest Rate Risk Exposure, Short-Term Market Interest Rates & Commercial Banks.

Effect of operational and market risk exposures on financial performance of DT-Saccos in Kenya

The main aim of the investigation was to analyze the effect of operational and market risk exposures on the financial performance of DT-SACCOs in Kenya. The specific objectives of the study were to; assess the effect of operating expense risk exposure on the financial performance of DT-SACCOs in Kenya; To establish the effect of operation efficiency risk exposure on the financial performance of DT-SACCOs in Kenya; Effect of interest rate risk exposure on the financial performance of DT-SACCOs in Kenya; Effect of foreign exchange rate risk exposure on the financial performance of DT-SACCOs in Kenya. Effect of operational and market risk exposure on the financial performance of DT-SACCOs in Kenya. The study used panel data between the years 2010-2019 which was 10 years period. The results revealed that at both bivariate and multivariate regression operating expense risk, operating efficiency and foreign exchange risk exposure had a significant effect on the financial performance of DT-SACCOs in Kenya. Only interest rate risk exposure did not have a significant effect on the financial performance of DT-SACCOs in Kenya.

Maturity-Matched Bond Fund Performance

Performance regressions lever expected benchmark returns linearly to the risk exposures of the fund. The interest rate (IR) risk premium, however, usually follows a decreasingly upward-sloping yield curve, characterizing the nonlinearity between expected return and IR risk exposure—for example, maturity or duration. If the exposures of the fund and the benchmark differ, this discrepancy causes alpha to deviate from the active bond selection performance it is supposed to measure. Performance ratings and investor flows are affected by this alpha deviation. Our simple remedy is to individually match funds and benchmarks using their durations. Beta and R2 are candidates for alternative matchings.

Research on Interest Rate Risk of Housing Mortgage Loan Based on Computer Simulation.

In recent years, with the rapid increase of the business volume of housing mortgage loans of commercial banks, the risk of prepayment is increasingly exposed. Prepayment will have a great impact on the duration and convexity of housing mortgage loans of commercial banks and then bring difficulties to the asset liability management of banks. Therefore, empirical research on the changes of duration and convexity of housing mortgage loans caused by prepayment when the market interest rate changes is of great significance for commercial banks to manage interest rate risk exposure. Based on the analysis of the option characteristics of prepayable housing mortgage loan, the CIR model with GARCH(1, 1) is selected to describe the interest rate change path, and the computer simulation method is used to calculate OAS and then calculate the effective duration and effective convexity of housing mortgage loan under different prepayment rates, so as to understand the interest rate risk of housing mortgage loan in the presence of embedded option.

The impact of interest rate risk on bank lending

Abstract This paper analyzes the transmission of realized interest rate risk to bank lending. It exploits unique supervisory information about the interest rate risk exposure of Swiss banks net of hedging. By weakening the banks’ economic capital, realized interest rate risk explains on average around one eighth or 30 basis points of the predicted total reduction in cumulative loan growth a year after an upward shock in nominal rates by one percentage point. Moreover, heterogeneity in exposures implies that the effects would differ across institutions. Finally, bank lending is mainly driven by the banks’ capital- rather than their liquidity-situation.

What drives the short‐term fluctuations of banks' exposure to interest rate risk?

AbstractWe investigate whether banks actively manage their exposure to interest rate risk in the short run. Using bank‐level data of German banks for the period 2011Q4–2017Q2, we find evidence that banks actively manage their interest rate risk exposure in their banking books. Specifically, they adjust their exposure to the earning opportunities presented by this risk, take account of their regulatory situation, and manage this exposure using interest swaps. We also find that the fixed‐interest period of housing loans has an impact on the banks' overall exposure to interest rate risk. This last finding, in combination with the empirical evidence that customer preferences predominantly determine the fixed‐interest period of these loans, is not in line with active interest rate risk management.

Interest rate derivatives and risk exposure: Evidence from the life insurance industry

Our primary aim in this study is to determine the relation that exists between the use of interest rate derivatives by public-traded life insurance firms and their exposure to interest rate risk. Based upon the annual reports and 10-K filings of US life insurers, covering the years 2000–2016, we find that those insurers with greater inherent exposure to interest rate risk also have a propensity for extensive engagement in the use of interest rate derivatives. We further reveal that life insurers with a propensity for the extensive use of such instruments during the 2000–2009 sub-period tend to have greater observable exposure to interest rate risk. However, during the 2010–2016 sub-period life insurers that use more interest rate derivatives tend to have smaller interest rate exposure. Since restructuring the balance sheet of a life insurer is costly, our results suggest that managers probably use derivatives as a means of modifying their risk tolerance to achieve the same results of direct duration matching.

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What Drives the Short-Term Fluctuations of Banks' Exposure to Interest Rate Risk?

We investigate whether banks actively manage their exposure to interest rate risk in the short run. Using bank-level data of German banks for the period 2011Q4- 2017Q2, we find evidence that banks actively manage their interest rate risk exposure in their banking books: They take account of their regulatory situation and adjust their exposure to the earning opportunities of this risk. We also find that the customers' preferences predominantly determine the fixed-interest period of housing loans and that the fixed-interest period of these loans has an impact on the banks' overall exposure to interest rate risk. This last finding is not in line with active interest rate risk management.

Euro Area Banks' Interest Rate Risk Exposure to Level, Slope and Curvature Swings in the Yield Curve

This paper investigates interest rate risk exposures of listed euro area banks which fall under the Single Supervisory Mechanism (SSM). We analyze the period 2005 to 2014, as it includes times of very low interest rates in which banks may have pursued a more risky maturity transformation strategy. First, we use the Bayesian DCC M-GARCH model to assess banks' stock price sensitivities to principal components of changes in the yield curve describing shifts in its level, slope and curvature. Second, we investigate how these sensitivities vary depending on bank-level characteristics (e.g., balance sheet composition, reliance on interest income). Our findings reveal that, on average, banks benefit from positive level shifts and steepening yield curves. Curvature changes affect banks' share prices as well, particularly in times of crises. Further, these sensitivities change in time and depend heavily on the bank's business model and balance sheet composition. Our analysis reveals that banks with larger balance sheets, higher capital ratios, higher parts of customer loans and lower parts of deposits are particularly sensitive to interest rate movements.

Australian financial firms’ exposures to the level, slope, and curvature of the interest rate term structure

ABSTRACTThis study examines the risk exposure of Australian financial firms to changes in the term structure of interest rates. Non-linearity in the interest rate term structure is captured by the three-factor model of interest rate level, slope, and curvature. We observe that financial firms have negative exposures to the interest rate level, while non-financial firms have positive exposures. This finding suggests that financial firms need to hedge against rising interest rates, while non-financial firms need to hedge against falling interest rates. Small banks and insurance companies have a positive risk exposure to the slope factor, while real estate firms have a negative risk exposure to the curvature factor. Though the interest rate level is the most important factor, ignoring the slope and curvature factors could lead to underestimating a financial firm’s overall interest rate risk exposure. These findings are robust to controlling for the orthogonalized market return, time-varying equity risk premium, and the global financial crisis. This study offers practical tools to regulators, such as the Reserve Bank of Australia and Australian Prudential Regulatory Authority for assessing interest rate risk exposures of the financial and non-financial sectors.

Effects of derivatives usage and financial statement items on capital market risk measures of Bank stocks: evidence from India

This paper examines the impact of off-balance sheet derivatives usage by banks combined with financial statement items on their capital market risk measures. Financial markets liberalization policies in the 1990s, led to a surge in investment in Indian banks’ stocks, and therefore, understanding capital market risk is of critical interest to domestic and foreign investors in bank stocks, as well as to bank managers. Using panel data analysis of publicly listed private and public sector banks, our findings indicate that bank size, core capital-to-risk adjusted asset ratio, and interest spread of banks are significantly related to the total return risk of bank stocks. The market risk of bank stocks is significantly positively related to the amount of derivatives usage and to the return on asset ratio of banks. Also, the firm-specific risk component of bank stocks is significantly affected by the volume of total assets, interest spread, and their core capital-to-asset ratio. The interest rate risk exposure of bank stocks is significantly related to the core capital-to-asset ratio, and the interest spread. The off-balance sheet derivatives exposure, bank size, and the core capital to risk adjusted asset ratios are seen to have a significant effect on the overall systematic risk component of the bank stocks. The bank ownership structure, i.e., private versus public sector banks do not have any significant effect on the capital market risk measures.

The Effect of Market Risk on Financial Performance of Commercial Banks in Kenya

Despite the growth in the Kenyan banking sector, market risk still remains a major challenge. The objective of study was to assess the effect of market risk on financial performance of commercial banks in Kenya. The study covered the period between year 2005 and 2014. Market risk was measured by degree of financial leverage, interest rate risk and foreign exchange exposure while financial performance was measured by return on equity. The study used the balance sheets components and financial ratios for 43 registered commercial banks in Kenya. Panel data techniques of random effects, fixed effects estimation and generalized method of moments (GMM) were used to purge time–invariant unobserved firm specific effects and to mitigate potential endogeneity problems. The pairwise correlations between the variables were carried out. F- test was used to determine the significance of the regression while the coefficient of determination, within and between R², were used to determine how much variation in dependent variable is explained by independent variables. From the results financial leverage, interest rate and foreign exchange exposure have negative and significant relationship with bank profitability. Based on the study findings, it is recommended that commercial banks especially locally owned are required to consider finding ways of mitigating the market risks by use of financial instruments such as financial derivatives and be active in derivatives markets. These may reduce their interest rate risk and foreign currency risk exposure. The commercial banks are also required to monitor the financial leverage so as to reduce the financial risk.

Risk Management in Financial Institutions

We study risk management in financial institutions using data on hedging of interest rate risk by banks and bank holding companies. We find strong evidence that better capitalized institutions hedge more both in the cross-section and within institutions over time. For identification, we exploit net worth shocks resulting from loan losses due to drops in house prices. Institutions that sustain such losses reduce hedging substantially relative to otherwise similar institutions. The evidence is consistent with the theory that financial constraints impede both financing and hedging. We find no evidence that risk shifting, adjustments of interest rate risk exposures, or regulatory capital explain hedging behavior.

Derivative Use by Commercial Banks in Bangladesh

Derivative use by commercial banks operating in Bangladesh is hypothesized to improve their intermediary functions. The study outcome identifies the influence of derivative use on the growth of advances by commercial banks. Bank’s participation in advances increases with increase in hedging activities through futures. It has also been found that the Bangladeshi private sector commercial banks have a high exposure of risk and have externalized their risk management process. Specialized banks of Bangladesh have a low risk exposure level, but still they have moderately externalized their risk management practices. Bangladeshi public commercial banks have a large deposit base and high risk exposure but are still internalizing their risk through risk management. The policy implication of this study is that derivative use by commercial banks is likely to increase the intermediary role of banks, i.e., the increase in advances growth rate rather than investment portfolio growth rate. Commercial banks with large deposit base could gain relatively by externalizing their risk management practices since this study reveals that interest rate risk exposure of derivative users is statistically lesser than non-users.