Interest rate risk an overview sciencedirect topics. Banks may also be subject to interest rate risk through interest sensitivity of their noninterest income. Sensitivity analysis of irrbb stress test 2017 final results. Financial statements and other financial information may include uncertainties. This booklet applies to the occs supervision of national banks and federal savings associations.
Net portfolio value is defined as the net present value of assets, liabilities and offbalance sheet contracts. It projects the changes in asset and liability cash flows, expressed in terms of nii, over a specified time horizon for defined interest rates scenarios. Impact of such uncertainties may be assessed using sensitivity analysis. Analyses if the dependency in turn helps in assessing the risk. During the study period, average net interest income for community banks varied from a high of 4. Gap is a traditional measure of risk in alm representing the outstanding risk position per time bucket. Pdf a sensitivity analysis of the elasticity of taxable. Earnings analysis using the net interest income at risk reporting template. Is this topic on the agenda for the mfis assetliability management committee or equivalent.
Sensitivity of bank net interest margins and profitability to. Apr 02, 2020 interest rate sensitivity is a measure of how much the price of a fixed income asset will fluctuate as a result of changes in the interest rate environment. An alternative method for measuring interestrate risk, called duration gap analysis, examines the sensitivity of the market value of the financial institutions net worth to changes in interest rates. While the median bank matches interest income and interest expenses well, i show that the majority of banks have large positive or negative net interest income sensitivity to rate changes. Analysis of change effect in the market interest rate on. If the bank does not want net interest income to fall by more than 25% during the next year, how large can the cumulative gap be to achieve the allowable change in net interest income. Figure 1 shows the average net interest income over the study period.
As expected, the monitoring of fixed rate gap is done by most of the banks 92%. Nii is the difference between a interest payments the. Heterogeneity in netinterest income exposure to interest. Most notably, the stability of commercial bank net interest margins the ratio of net interest income to average assets lends credence to. The sensitivity of net interest margins to interest rate volatility for different groups of banks varies across subsample periods. The equilibrium levels of income and interest rate change when either the is curve or the lm curve shifts to a new position either to the right or to the left. Net interest income, balance sheet structure and interest rates. The net interest income not the margin, but the aggregate profit in the banking system has grown in 35 of the last 37 years, and just about every single year since 1934 when record keeping began. To introduce the net interest income at risk reporting template we will use a simplified stylized case study. After completing your financial budgets step 1, your first year forecasted cash flow statement step 2, your first year forecasted income statement step 3, your first year forecasted balance sheet step 4 your first year forecasted ratios step 5, and your first year forecasted breakeven point step 6, the next step is to develop your. Steps to earnings sensitivity analysis forecast future interest rates identify changes in the composition of assets and liabilities in different rate environments forecast when embedded options will be exercised identify when specific assets and liabilities will reprice given the rate environment estimate net interest income and net income. Sensitivity to market risk banking control commission of. Contacts 85 keeping in touch 86 acknowledgements 88.
Net interest income nii is the difference between revenues generated by interestbearing assets and the cost of servicing interestburdened liabilities. First, the object of our analysis is net interest income, rather than the fair values of recognized financial instruments. The fdic has identified industry trends that highlight the importance of careful management of sensitivity to interest rate risk. Managing sensitivity to market risk in a challenging interest rate environment. Helps in identifying how dependent the output is on a particular input value. In this post, we are going to see sensitivity analysis in excel. This method involves amongst other things analyzing the impact of factors like cost of equity or change in riskfree rate on the price of a. From the analysis it seems that there is a direct level and variability or indirect through the balance sheet structure influence of nominal interest rates on net interest margin of the banks. Depending on a banks specific assets and liabilities e. Sensitivity of bank net interest margins and profitability. Sensitivity analysis example continued npv calculations for pessimistic investment scenario net cash flow 6,200 780 operating cash flow 780 profit after tax 330.
A sensitivity analysis, otherwise known as a whatif analysis or a data table, is another in a long line of powerful excel tools that allows a user to see what the desired result of the financial model would be under different circumstances. If demand for money is not much sensitive to level of income, then k will be small. The liabilities consist primarily of customers deposits. Validation of nii subcomponents net interest income is one of the primary components of ppnr. A common fallacy of interest sensitivity analysis is to attribute all credit cycle variation.
Interest rate risk and bank net interest margins bis. Dollargapanalysisand netinterestincome sensitivity whatyouneedtoknow. Uncertainty and sensitivity analyses denver, colorado. What explains low net interest income at community banks. Mar 29, 2018 sensitivity analysis is a method for predicting the outcome of a decision if a situation turns out to be different compared to the key predictions. Despite the rate increase, the projection for net interest income is a decline from 159 million to 6. Algebraic analysis of is lm model with numerical problems. Sensitivity analysis in accounting accounting guide.
Does the mfi have the tools to accurately measure its level of net interest income sensitivity. In other words, banks with positive net interest positions will experience reductions in net interest income as the market interest rate declines and increases when the interest rate rises. Ifrs 7 requires disclosure of information about the significance of financial instruments to an entity, and the nature and extent of risks arising from those financial instruments, both in qualitative and quantitative terms. Net interest income for the second half of 2014 was 3. These impacts could relate to financial instruments measured at any of amortised cost, fair value through. Applicability this booklet applies to the occs supervision of national banks and federal savings associations. Simulation model of sensitivity of net interest income to the. Interest rate risk and bank net interest margins bis quarterly. The analysis of the factors a ecting net interest income of the banking sector is.
For example, sensitivity analysis can be used to study the effect of a change in interest rates on bond prices if the interest rates increased by 1%. This test measures the impact on net interest income and on net portfolio value of an immediate change in interest rates in 100 basis point increments. Ifrs 7 was originally issued in august 2005 and applies to. Here is a chart of net interest income in the us banking system in dollar terms over the past 37 years since rates peaked in 1982. Oct 18, 2012 scenario or sensitivity analysis and stress testing requirements have been used for subprime lending, interest rate risk, and liquidity management for several years. Net interest income represents the largest component of bank earnings. Overview of sensitivity analysis what is sensitivity analysis. The conventional wisdom that interest rate risk does not pose a signi.
Pdf interest rate risk management using economic value. In summary, the following sections explain that changes to the yield curve drive general. Our focus on net interest income is motivated both by its economic significance and its importance to risk management strategies. Sensitivity analysis on irrbb stress test 2017 final results. It is computed by forecasting balances, including originations and pricing rates. The article discusses the practical aspects of measuring and managing the interest rate risk by scenario analysis and sensitivity model. Nii simulation is a modelling technique that looks at irr through an earningsatrisk construct. Estimates of top income and wealth shares in us household survey data are generally lower than the estimates from us administrative income tax data. There are different techniques for measuring interest rate risk. Keeping all other factors constant, banks can reduce the volatility of the net interest income by. Pdf a sensitivity analysis of the elasticity of taxable income. Simulation model of sensitivity of net interest income to the changes in the market interest rate in the banks siauliai bankas and medicinos bankas to make calculations of net interest income it is necessary to know the estimates of the total interest income and income cost. For banks, the assets typically include commercial and personal loans, mortgages, construction loans and investment securities. Most notably, the stability of commercial bank net interest margins the ratio of net interest income to average assets lends credence to this conclusion.
The sensitivity of net interest margins to interestrate volatility for different groups of banks varies across subsample periods. The model is constructed on already made income gap or. Sensitivity to market risk reflects the degree to which changes in. Sensitivity analysis of irrbb stress test 2017 ecb banking. On thebasis of gap analysis methods applied to make anassessment of an interest rate risk and annual financialstatements of the banks siauliai bankas and medicinosbankas for the period of 2006 2009, a theoreticalsimulation model of sensitivity of the net interest income tothe changes in the market interest rate was developed. The gap position gauges a banks exposure to interest rate risk. In other words, a good way to determine whether a company is effectively using its.
Analysts use the net interest margin to determine whether the earning assets are actually making enough money to justify the interest expense or if the company wouldve been better off just paying off its debts to decrease the interest expense. An alternative method for measuring interest rate risk, called duration gap analysis, examines the sensitivity of the market value of the financial institutions net worth to changes in interest rates. Pdf basis risk and net interest income of banks researchgate. Corporations analysis of its interest rate sensitivity. If the disclosures are both useful in predicting future changes in net interest income and used by analysts in their forecasts of changes in net interest income, then more less predictive disclosures should be associated with higher lower analyst forecast accuracy with. Specific disclosures are required in relation to transferred financial assets and a number of other matters. Interest rate sensitivity is a measure of how much the price of a fixedincome asset will fluctuate as a result of changes in the interest rate environment. Duration analysis is based on macaulays concept of duration, which measures the average lifetime of a securitys stream of payments.
Usefulness of interest income sensitivity disclosures mei cheng. Deterministic sensitivity analysis well focus on simple deterministic sensitivity analyses oneway. Jul 31, 2014 figure 6 net interest income at risk calculation mechanics for the base case. Sensitivity to market risk bank analysis and examination school. Discounted cash flow is probably the commonest way of valuation of a company. Monash business school bff3651 week4 interestraterisk. In the long run, the direct effects have the major impact, while in the short run the indirect effects do. Net interest income is the difference between the revenue that is generated from a banks assets and the expenses associated with paying out its liabilities. Financial sensitivity analysis is done within defined boundaries that are determined by the set of independent input variables.
Income gap analysis the sensitivity of bank income to changes in interest rates can be measured more directly using gap analysis also called income gap analysis. We focus our analysis primarily on variations in net interest margins, although. Net interest income or the market value of stockholders equity the alco coordinates the banks strategies to achieve the optimal riskreward tradeoff. Pdf the results of the banking sector are shaped primarily by commissions and. In this article, we will describe the nature of sensitivity analysis and how it can be performed. This booklet provides an overview of interest rate risk comprising repricing risk, basis risk, yield curve risk, and options risk and discusses irr management practices. How analysts calculate the net interest margin dummies. Finally, by investigating the sensitivity of roa to interest rate and credit. Because of the change in interest rate, there has been a shift in net interest income. Usefulness of interest income sensitivity disclosures. Lets take a quick look at the reporting template and some of the calculations. The analysis of net interest margins presented here has left aside two. Gap analysis a static measure of risk that is commonly associated with net interest income margin targeting earnings sensitivity analysis. Analysis of change effect in the market interest rate on net.
An analysis of commercial bank exposure to interest rate risk. Financial institution letters fil4620 october 8, 20. Simulation model of sensitivity of net interest income to. Net interest income, balance sheet structure and interest.
Sensitivity analysis of irrbb stress test 2017 final. It allows the user to select two variables, or assumptions, in the model and see how a desired output. Sensitivity analysis on irrbb stress test 2017 final results two. Interest rate risk management using income gap analysis.
The earnings analysis is more fine tuned and is used more commonly. Higher interest rates would lead to higher net interest income in the. Example sensitivity analysis showing how these risks might be calculated the sensitivity analysis over the page illustrates the potential impact on the income statement and equity for reasonably possible market movements. The result was actually negative net interest income for two years. Has it undertaken an analysis of the chief causes for the volatility if relevant. However, these top share estimates are sensitive to the unit of analysis, the income concept being measured, and, in the case of wealth, to assumptions about the correlation between income and. Change one parameter at a time keeping all others constant standard way of presenting oneway sensitivity analyses results is to plot the parameter you are changing in the xaxis and an output of interest on the yaxis.