Quantifying the Interest Rate Risk of Banks: Assumptions Do Matter

This paper analyzes the robustness of the standardized framework suggested by the BaselCommittee on Banking Supervision (2004b) to quantify the interest rate risk of banks. Wegeneralize the Committees model and use data on the German universal banking systemwhich is not publicly available to study the impact of different model specifications on theestimated level of interest rate risk: the number and boundaries of the time bands, thedistribution of business within the time bands, amortization rates, coupons, and the economicmaturity of non-maturing deposits. We find that the respective estimates are very sensitive tothese values. Depending on the model specification, banks can easily be judged as either high-risk or low-risk banks. We conclude that banking supervisors and banks should spend moreeffort on developing a reliable approach for measuring interest rate risk as the standardizedframework can lead to significant misjudgments.