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An economic capital model integrating credit and interest rate risk in the banking book

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  • Alessandri, Piergiorgio
  • Drehmann, Mathias

Abstract

Banks often measure credit and interest rate risk in the banking book separately and then add the risk measures to determine economic capital. This approach misses complex interactions between the two risk types. We develop a framework where these risks are analysed jointly. Since banking book positions are generally not marked to market, our model is based on book value accounting. Our simulations show that interactions matter, and that ignoring them leads to risk overstatement. The magnitude of the errors depends on the structure of the balance sheet and on the repricing characteristics of assets and liabilities.

Suggested Citation

  • Alessandri, Piergiorgio & Drehmann, Mathias, 2010. "An economic capital model integrating credit and interest rate risk in the banking book," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 730-742, April.
    • Handle: RePEc:eee:jbfina:v:34:y:2010:i:4:p:730-742
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    More about this item

    Keywords

    Economic capital Risk management Credit risk Interest rate risk Asset and liability management;

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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