Estimating the Interest Rate Sensitivity of Liquid Retail Deposit Values

One of the most difficult issues in the measurement of bank interest rate risk is the interest rate risk of liquid retail deposits. In this study, estimates are developed for the interest rate sensitivity of the value of interest-bearing checkable deposits (OCDs) and savings deposits defined to include MMDAs and other savings accounts. These interest rate sensitivities are measured by the percentage change in the value of the deposit liability due to a change in market interest rates which, for a permant rate shock and hence parallel yield curve shift, represent the deposit's quot;duration.quot; The value of the deposit liability is equal to the deposit balance net of the present value of economic profits earned on the liability. Because deposit rates adjust upward to market rates more slowly than downward, the interest rate sensitivity of the economic profits from liquid deposit accounts tends to be greater when deposit rates are rising than when they are falling. As a consequence, durations tend to be relatively large when deposit rates are moving up and small when deposit rates are moving down. Durations are estimated for permanent shocks to market rates for aggregated deposit categories and for individual banks. The consequences for deposit interest rate sensitivities are further examined for stochastic, mean-reverting market rates and nonparellel yield curve shifts