Quantifying the Interest Rate Risk of Banks: Assumptions Do Matter

Abstract:     
This paper analyzes the robustness of the standardized framework proposed by the Basel Committee on Banking Supervision (2004b) to quantify the interest rate risk of banks. We generalize this framework and study the change in the estimated level of interest rate risk if the strict assumptions of the standardized framework are violated. Using data on the German universal banking system, we find that estimates of the interest rate risk are very sensitive to the framework’s assumptions. We conclude that the results obtained using the standardized framework in its current specification should be treated with caution when used for supervisory and risk management purposes.

Keywords: interest rate risk, Basel Capital Accord, banking supervision, standardized interest rate shock

JEL Classification: G18, G21

Accepted Paper Series