A modelling process of short-term interest rate risk management for the South African commercial banking sector

ENGLISH ABSTRACT: This study focuses on banking book interest rate risk management, more specifically shortterminterest rate risk management problems. This type of risk is induced by the inflationtargeting policy of the South African Reserve Bank. As a result, inflation leads to an uncertaininterest rate cycle and a period of uncertain interest rate levels as it relates to lending andborrowing products in the South African commercial banking sector.The lending rates of most South African commercial banks are tied to the prime overdraftrate. The borrowing rates are linked to the money market rates such as the JohannesburgInterbank Agreed Rate (JIBAR) which is indirectly affected by the prime overdraft rate.Hence, lending and borrowing rates are related to the repo-rate. Furthermore, a fixedrelationship exists between the prime overdraft rate and the repo-rate. The monetary policycommittee meets every two months during the year to make inflation and repo-rateadjustments, as stipulated in the inflation targeting policy. A subject portfolio containingfixed-rate loans, advances and floating-rate deposits is exposed to the change of the repo-rate.This short-term banking book interest rate risk is defined based on the fact that the repo-rateadjustment occurs every two months, the banking book risk management is short termfocused, and hedging instruments against interest rate risk are short term dated contracts. Sucha short term risk may have a negative impact on the bank’s profitability.The study starts with a review of the bank risk management processes, and then discusses theenterprise risk management framework that guides the formation of the risk managementprocesses and systems. In order to benchmark against international risk management practices,a comparative analysis is carried out to evaluate the risk management tendencies of bank riskmanagement in South Africa and globally.The empirical findings reveal that most banks (i.e. eighty per cent of all local banks) managethe short-term interest rate risk by following the same process as the interest rate risk ingeneral. The key elements (risk identification, measurement, mitigation and monitoring andreporting) of the banking book interest rate risk management are not linked together as asystematic process. This is not in line with the Basel II Accord to manage market risksthrough a process approach.The study also proposes a generic short-term interest rate risk management framework and in doing so, addresses some of the weaknesses of current risk management practices. Based onthis framework, the South African banks may develop their own processes to manage suchshort-term banking book interest rate risk exposure.Some of the problems of bank risk management that come to light from the empirical findings,are summarised in the last chapter and may be considered for future research.