Interest Rate Risk

Interest rate risk refers to the possibility that uncertainty in market interest rate changes will cause losses to commercial banks. Interest rate risk is one of the main financial risks of banks. Since there are many factors that affect interest rate changes, interest rate changes are more difficult to predict. One of the focuses of banks' daily management is how to control interest rate risk. The management of interest rate risk relies to a large extent on banks' management of their own deposit structures and the use of some new financial instruments to avoid risks or seek to benefit from risks.

Classification of Interest Rate Risk

The Basel Committee on Banking Supervision divides interest rate risk into four categories: repricing risk, basis risk, yield curve risk and option risk.

Repricing risk is the most important interest rate risk and arises from the mismatch between repricing timing (for floating rates) and maturity dates (for fixed rates) of bank assets, liabilities and off-balance sheet positions. The difference between interest-rate-sensitive assets and interest-rate-sensitive liabilities within a certain period of time is usually called the "repricing gap." As long as the gap is not zero, when interest rates change, banks will be exposed to interest rate risk.

Basis risk refers to when changes in the general interest rate level cause the interest rates of different types of financial instruments to change to varying degrees, banks will face basis risk. Even if a bank's assets and liabilities are repriced at the same time, banks will face risks as long as deposit rates and lending rates are not adjusted exactly the same.

Yield curve risk refers to the adverse impact on a bank's net interest margin income and asset intrinsic value due to unexpected shifts or sudden changes in the slope of the yield curve. The yield curve is a curve obtained by connecting the yields of bonds of various maturities. When the bank's deposit and loan interest rates are set based on the yield of treasury bills, the yield curve risk will appear. The slope of the yield curve changes with different stages of the economic cycle, giving the yield curve different shapes.

Option risk refers to the possibility that when interest rates change, bank customers will exercise options implicit in the bank's balance sheet business and cause losses to the bank. That is, the interest rate risk arising from the customer's potential choices of early repayment of loan principal and interest and early withdrawal of deposits. Since China has lowered deposit and loan interest rates several times since 1996, many companies have "borrowed new and repaid old", repaying unexpired loans in advance and borrowing loans with lower interest rates to reduce financing costs; at the same time, the interest rate risk awareness of individual customers has also increased. In addition, China's current lack of policy restrictions on customers' prepayment defaults makes option risks increasingly prominent in China's commercial banks.

Interest rate risk management methods

Interest rate risk management is an important part of asset and liability management of Western commercial banks. It is the main tool to increase bank operating income and stabilize the bank's market value. Interest rate risk management is an important part of risk management for commercial banks. On the basis of interest rate prediction and interest rate risk measurement, there are two main categories of interest rate risk management:

One is the traditional on-balance sheet management method, which achieves the purpose of controlling interest rate risk by increasing (or reducing) the position of assets or liabilities, or changing the internal structure of assets or liabilities (such as constructing an immune asset portfolio);

The other type is the off-balance sheet management method, which is mainly used to temporarily maintain the value of existing asset and liability positions and to target a certain asset or liability business that is relatively risky or difficult to be included in the interest rate risk measurement system of commercial banks. Financial derivatives and other off-balance sheet items are arranged to "hedging" them.

The need for interest rate risk management

Under the current situation where my country's interest rate marketization is accelerating, interest rate risk management should become one of the core contents of asset and liability management of all commercial banks in my country. All commercial banks should establish a set of scientific and effective modern interest rate management mechanisms to calmly welcome the arrival of interest rate marketization, so as to avoid being trapped in a passive position due to lack of preparation in the early stages of interest rate marketization. The necessity of interest rate risk management is mainly reflected in the following aspects:

Interest rate marketization and interest rate risk management. Due to the imperfect internal control mechanism of interest rates in state-owned commercial banks, the failure to establish an effective domestic capital allocation mechanism, and the need to improve the interest rate control capabilities of the People's Bank of China, the market-oriented reform of interest rates has progressed relatively slowly. However, the degree of marketization of interest rates in our country is already relatively high. For example, interest rates on various types of bonds, some loan rates, and large deposit rates have actually been fully marketized. With the further advancement of my country's interest rate marketization reform, the degree of interest rate marketization will be further improved, interest rate levels and their structures will change more and more frequently, and commercial banks will also face increasing interest rate risks. Correspondingly, the quality of interest rate risk management of commercial banks will directly affect their operating performance, which in turn will affect the pace of the People's Bank of China's interest rate market reform.