What Does the Federal Reserve's Economic Value Model Tell Us About Interest Rate Risk at U.S. Community Banks?

FRB of St. Louis Supervisory Policy Analysis Working Paper No. 2003-01

37 Pages Posted: 12 Jul 2004

See all articles by Gregory E Sierra

Gregory E Sierra

Southern Illinois University Edwardsville

Timothy J. Yeager

University of Arkansas - Sam M. Walton College of Business

Date Written: July 2004

Abstract

The savings and loan crisis of the 1980s revealed the vulnerability of some depository institutions to changes in interest rates. Since that episode, U.S. bank supervisors have placed more emphasis on monitoring the interest rate risk of commercial banks. One outcome developed by economists at the Federal Reserve Board of Governors was a duration-based Economic Value Model (EVM) designed to estimate the interest rate sensitivity of banks.

We test whether measures derived from the Fed's EVM are correlated with the interest rate sensitivity of U.S. community banks. The answer to this question is important because bank supervisors rely on EVM measures for monitoring and scoping bank-level interest rate sensitivity.

We find that the Federal Reserve's EVM is indeed correlated with banks' interest rate sensitivity and conclude that supervisors can rely on this tool to help assess a bank's interest rate risk. Our results are consistent with prior research that finds the average interest rate risk at banks to be modest, though we do not consider the potential interaction between interest rate risk and other risk factors.

Keywords: Interest rate risk, community banks, economic value of equity, duration

JEL Classification: G21

Suggested Citation

Sierra, Gregory E. and Yeager, Timothy J., What Does the Federal Reserve's Economic Value Model Tell Us About Interest Rate Risk at U.S. Community Banks? (July 2004). FRB of St. Louis Supervisory Policy Analysis Working Paper No. 2003-01, Available at SSRN: https://ssrn.com/abstract=563345 or http://dx.doi.org/10.2139/ssrn.563345

Gregory E. Sierra

Southern Illinois University Edwardsville ( email )

Campus Box 1104
Edwardsville, IL 62026-1102
United States
618-650-2633 (Phone)

Timothy J. Yeager (Contact Author)

University of Arkansas - Sam M. Walton College of Business ( email )

Fayetteville, AR 72701
United States

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