Interest Rate Risk on the Banking Book

The essay provides a basic framework for the measurement of interest rate risk, that is consistent with the provisions of Pillar 2. To that aim, the chapter first describes how interest rate risk on the banking book is regulated in the new Basel Accord and in other Basel Committee documents; it then presents the main approaches used to measure interest rate risk in banks, distinguishing between methods that rely on the Earnings at Risk (EaR) paradigm and the Value at Risk (VaR) perspective, and showing how they can be used to quantify the effect, on the bank’s value, of a 2% shift in market rates (as required by Pillar 2). The essay also extensively discusses the treatment of non-maturing assets and liabilities, that is, of balance-sheet items that, while being formally on demand, react to market rate changes only partially and with delay and provides a general framework for dealing with the indirect effects of interest rate risk on the banking book.