INTEREST RATE RISK

The risk incurred by an FI when the maturities of its

assets and liabilities are mismatched and interest rates
are volatile

REFINANCING RISK
The risk that the cost of rolling over or re-borrowing
funds will rise above the returns being earned on asset
investment
REINVESTMENT RISK
The risk that the returns on funds to be reinvested will
fall below the cost of funds
HOW TO MEASURE INTEREST RATE RISK:

Two techniques are used to measure interest rate risk,

1. Re-pricing Gap Analysis

2. Duration Gap Analysis

1-RE-PRICING GAP ANALYSIS

Re-pricing Gap is the difference between those assets whose interest
rates will be re-priced or changed over some future period (RSA) and
liabilities whose interest rates will be re-priced or changed over some
future period (RSL). The study of re-pricing gap as to how it may affect
interest income change in interest rate is known as re-pricing gap
analysis.

The gap is calculated for different maturity buckets for example,

 One day
 More than 1 day to 3 months
 More than 3 months to 6 months
 More than 6 months to 12 months
 More than 1 year to 5 years
 More than 5 years
 Also, for 1 year whole which will be cumulative Gap of the above
four maturity buckets

Rate sensitivity is the time to re-pricing of an asset or liability.

Mathematical representation:
∆NII = (RSAi – RSLi) * ∆R
∆NII = (RSAiX ∆R )– (RSLiX∆R)
ILLUSTRATION: 1

Notes:

 Federal funds are overnight borrowings between banks and other entities to maintain their
bank reserves at the Federal Reserve (State Bank). Banks keep reserves at Federal Reserve
Banks to meet their reserve requirements and to clear financial transactions.
 A money market account (MMA) or money market deposit account (MMDA) is a deposit
account that pays interest based on current interest rates in the money markets.
 Any type of short-term deposit held by a bank pays a variable rate of interest to the customer.
These liabilities include money market certificates, savings accounts and the Super NOW
account.

Required:

1. What is the repricing gap if the planning period is 30 days? 6 months? 1 year? 2 years? 5 years?
2. What is the impact over the next six months on net interest income if interest rates on RSAs
increase 60 basis points and on RSLs increase 40 basis points?
3. What is the impact over the next year on net interest income if interest rates on RSAs increase 60 basis
points and on RSLs increase 40 basis points?
2-Duration Gap Analysis
ILLUSTRATION – 2