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

  • Saha, Asish
  • Subramanian, V.
  • Basu, Sanjay
  • Mishra, Alok Kumar
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    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.

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    Article provided by Elsevier in its journal European Journal of Operational Research.

    Volume (Year): 193 (2009)
    Issue (Month): 2 (March)
    Pages: 581-590

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    Handle: RePEc:eee:ejores:v:193:y:2009:i:2:p:581-590
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    1. Granger, C. W. J., 1980. "Testing for causality : A personal viewpoint," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 329-352, May.
    2. Mark Flannery & Christopher James, . "Market Evidence on the Effective Maturity of Bank Assets and Liabilities," Rodney L. White Center for Financial Research Working Papers 05-83, Wharton School Rodney L. White Center for Financial Research.
    3. Flannery, Mark J, 1981. "Market Interest Rates and Commercial Bank Profitability: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 36(5), pages 1085-1101, December.
    4. Quémard, J L. & Golitin, V., 2005. "Interest rate risk in the French banking system," Financial Stability Review, Banque de France, issue 6, pages 81-94, June.
    5. Flannery, Mark J, 1983. "Interest Rates and Bank Profitability: Additional Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 15(3), pages 355-62, August.
    6. Konstantijn Maes, 2004. "Interest Rate Risk in the Belgian Banking Sector," Financial Stability Review, National Bank of Belgium, vol. 2(1), pages 157-179, June.
    7. Granger, C. W. J., 1988. "Some recent development in a concept of causality," Journal of Econometrics, Elsevier, vol. 39(1-2), pages 199-211.
    8. International Monetary Fund, 2004. "Interest Rate Volatility and Risk in Indian Banking," IMF Working Papers 04/17, International Monetary Fund.
    9. Flannery, Mark J & James, Christopher M, 1984. " The Effect of Interest Rate Changes on the Common Stock Returns of Financial Institutions," Journal of Finance, American Finance Association, vol. 39(4), pages 1141-53, September.
    10. Wetmore, Jill L. & Brick, John R., 1998. "The Basis Risk Component of Commercial Bank Stock Returns," Journal of Economics and Business, Elsevier, vol. 50(1), pages 67-76, January.
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