Pre ClassPPT 6

8/11/2019 Pre ClassPPT 6

1/7

Interest Rate Risk-2Objective

In this session ,we will comprehend the following two

variants of interest rate risk.

Basis Risk

Yield curve Risk


2/7

Basis Risk

We assume that changes in interest rates equally affect both the assets andliabilities.

But in reality, the extent of change in interest rate on re-pricing will dependupon the specific asset/liability subject to re-pricing.

The risk of different groups of banks assets and liabilities being based on

different interest rate basis (like MIBOR, treasury bill rates etc.)which change byvarying degrees (in response to a given change in the key interest rates in themarket )is called Basis Risk.

Changes in deposit interest typically lag behind loan rates.

The complex linkages between interest rates in different segments of the market(Call,Repos,CDs,Interbank term money etc.) contribute to basis risk.

Whatever be the underlying reasons, bank's net interest income will beimpacted by basis risk.

Typically, in a falling interest rate scenario, it is possible that interest rates onassets may be lowered generally while the deposits may continue at thecontacted higher interest rates.


3/7

Basis Risk

The following illustration will make the concept ofBasis risk clear.

The Bharat Bank Limited

(Interest Sensitivity Gap Position 1-30 days Bucket)

Liabilities Assets

Call Money 50 Treasury Bills 30

Repo 50 Advances 120

Deposits 100

Total 200 Total 150


4/7

Basis Risk

If interest rate rises by 1%,bank will lose 0.5crore peryear assuming that the rise in interest will be uniformlyapplicable to all the items of assets and liabilities.

But in reality, interest rates on assets and liabilities donot change in the same proportions. Let us assume thefollowing changes in interest rates.

1. Call money rate may go ,up by 1%

2. Repo by 0.5%

3. Deposits by 0.25%

4. Treasury bills by 1.0%

5. Advances by 0.75%


5/7

Basis Risk

The impact of changes will be as follows:

Interest on liability/AssetCall 50 0.01 % high 0.5

Repo 50 0.005 % high 0.25

Deposits 100 0.0025 0.25

Treasury Bills 30 0.01 0.3Advances 120 0.0075 0.9

Net impact

on NII

0.20


6/7

YIELD CURVE RISK

On account of volatility in interest rates, the yieldcurve unpredictability and often substantiallychanges in shape.

If the interest rates on assets and liabilities arepegged to the bench mark rates (like treasury billscut-off rates ),there is the risk that the interestspread may decrease as term spread narrows

down.


7/7

YIELD CURVE RISKIllustration

Assume that the bank has raised a floating rate deposit which will be repriced1% above the 91 day Treasury Bills cut-off and invested the amount in afloating rate loan of the same re-pricing interval but at a spread of 2% above364 Day Treasury Bills cut-off .The following table shows the Yield curve Riskinvolved, as the spread between the two maturities of treasury bills

narrowed.Period 91 Day TB 364 Day TB Term

Spread

Interest spread

between deposit

& loan.

April1999 8.75% 10.07% 1.32% 2.32%

June1999 9.24% 10.32% 1.08% 2.08%

August 1999 9.46% 10.28% 0.82% 1.82%

March2000 9.16% 9.93% 0.77% 1.77%

Feb.20002 6.25% 6.42% 0.17% 1.17%

Pre ClassPPT 6

Documents

Transcript of Pre ClassPPT 6