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