Research On Interest Rate Risk Management Of Commercial Banks

Interest rate risk (IRR) has always been an important source of risks to commercial banks, especially under the conditions of the global economic integration, the financial liberalization and innovation. Over the past 20 years, financial institutions have made significant efforts to establish and improve their procedures for interest rate risk management, including using economic models of interest rate and related models of credit risk.In China, liberalization reform of interest rate is ongoing. After free-upping interest rate, volatility and uncertainty of interest will seriously affect costs and earnings of commercial banks. Yet the issue has been paid little attention by China's commercial banks. It is urgent that those banks should choose management methods fitting their own and establish efficient interest rate risk management based on actual conditions by learning advanced management techniques of IRR.This thesis focuses on how to manage the IRR of China's commercial banks by studying the methods on how to recognize, measure, and control the IRR.The first chapter is the basis of this thesis. It defines the concept of IRR which is the change in a bank's portfolio value due to interest rate fluctuations. IRR can be roughly decomposed into four categories: repricing risk, yield curve risk, basis risk, and optionality (see Basel Committee on Banking Supervision (BCBS) 2003). Ianalyze the reasons for producing IRR coming from internal and external banks. Internal reasons mean differences caused by the structure of assets and liabilities, such as asset-liability mismatch. External reasons include macro-economy and political changes, etc.The second chapter mainly introduces the tools, especially Duration GAP, on how to measure and evaluate IRR. Duration is a tool of approximating the sensitivity of the change in value of a set of cash flows with respect to changes in the interest rate. Since the price changes in assets and liabilities in banks are accurately reflected in interest revenues and expenses, we may obtain the duration GAP using interest revenues and expense changes instead.The third chapter analyzes the strategies of IRR management: Positive strategy and negative strategy. The former means that the bankers take some positive measures adjusting the quantity of assets and liabilities in order to change the Interest Sensitive GAP or Duration GAP to increase profits. The latter is an immunization strategy whose aim is to make a zero GAP to avoid IRR.The forth chapter mainly discusses the control of IRR. Balance management includes merger, acquisition, loan-security, short-term borrowing and long-term borrowing. Off-balance management includes forward, future, swap, option, cap, floor, collar, etc. The management can also use interest insurance to decrease the loss.The last chapter of this thesis uses some data to do empirical analysis. Based on the data from 1995 to 2002 on assets and liabilities for the top 7 largest commercial banks in China, I analyze the IRR these banks exposed by using Interest Sensitive Gap and Duration Gap Analysis, draw a conclusion that these banks confront a large amount of IRR, and then put forward some suggestions on how to construct the interest rate risk management system in China.