Networth exposure to interest rate risk: An empirical analysis of Indian commercial banks

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.ejor.2007.11.038 Byline: Asish Saha, V. Subramanian, Sanjay Basu, Alok Kumar Mishra Keywords: Interest rate risk in banks; Risk management; Simulation; Driver-driven variables Abstract: In the Basel II era, management of interest rate risk in the banking book has become significant. In the first study of its kind, we develop a simulation based driver-driven approach to estimate the impact of interest rate volatility on the networth of Indian banks during the period 2002-2004. We derive the interest rates that drive changes in deposit and prime lending rates (PLR). Then we perform Monte Carlo simulation and multiple regressions, on these driver rates, to obtain simulated shocks to deposit rates and PLR. We use these simulated shocks to get the 99% worst EVE loss for the sample banks. These losses are much larger than what the existing literature suggests. This is because, apart from repricing risk, we are the first to find evidence of significant basis risk. Our results have important policy implications both for banks and regulators. Author Affiliation: National Institute of Bank Management (NIBM), Pune, India Article History: Received 15 April 2006; Accepted 14 November 2007 Article Note: (footnote) [star] We are grateful to our colleague Dr. Arindam Bandyopadhyay for his valuable comments and suggestions. The usual disclaimer applies.