Lecture 2: Interest rate risk - the repricing model
Introduction
The level and movement of interest rates
The repricing model
Weakness of the repricing model
Interest rate risk arises: FIs mismatch the maturities of their assets and liabilities
interest rate volatility is directly linked to the monetary policy (RBA changes the cash rate)
also known as the funding gap model
focus on the changes of net interest income (NII)
assets: loan
liabilities: cash from depositors
monetary targets of money supply growth increased the interest rate volatility
NII = Interest Revenue - Interest Expense
Rate sensitivity asset/ liability (RSA/RSB): an asset/ liability whose interest rates will be priced or changed over a certain period
Rate sensitivity: time to repricing
Repricing may be result of
on reset date of a variable asset/ liability (some don't have fixed reset date => looks at historical data)
rollover of an asset/ liability on maturity
Repricing gap = RSA - RSL (over the same future period)
Repricing risk: when the maturity of assets exceeds the maturity of liabilities (short funded: refinancing risk) or vice versa (long funded: reinvestment risk)
page 16: equity is included in liabilities side
Net interest margin = NII/ earning assets
page 19: formula
CGAP/A: provides the direction and scale of the interest rate exposure
CGAP effects (page 31)
interest spread = earning assets interest rate - interest rate paid on liabilities (unequal changes in rates of RSAs and RSLs)
if spread increases then NII increases and vice versa
Market value effects
repricing model is not a complete measure
Over- aggregation
Runoffs
Off- balance sheet effect
repricing model only looks at on- balance sheet items