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An Analysis of Commercial Bank Exposure to Interest Rate Risk

Retail banking in the Philippines is still nascent, with consumer loans accounting for only about 10% of total bank lending and less than 5% of GDP. That said, the consumption-driven nature of the economy creates strong demand for consumer loans, with personal expenditure making up 77% of GDP (Fitch Ratings (2006)). In response, the banks have recently focused aggressively on retail lending, which is experiencing growth rates of more than 10% per annum (albeit starting from a low base). However, high delinquency rates have accompanied the growth of retail lending, especially unsecured lending, where overextension of credit to low-income. | An Analysis of Commercial Bank Exposure to IntereSt Rate Risk David M. Wright and James V. Houpt of the Board s Division of Banking Supervision and Regulation prepared this article. Leeto Tlou and Jonathan Hacker provided assistance. Banks earn returns to shareholders by accepting and managing risk including the risk that borrowers may default or that changes in interest rates may narrow the interest spread between assets and liabilities. Historically borrower defaults have created the greatest losses to commercial banks whereas interest margins have remained relatively stable even in times of high rate volatility. Although credit risk is likely to remain the dominant risk to banks technological advances and the emergence of new nancial products have provided them with dramatically more ef cient ways of increasing or decreasing interest rate and other market risks. On the whole these changes when considered in the context of the growing competition in nancial services have led to the perception among some industry observers that interest rate risk in commercial banking has signi cantly increased. This article evaluates some of the factors that may be affecting the level of interest rate risk among commercial banks and estimates the general magnitude and signi cance of this risk using data from the quarterly Reports of Condition and Income Call Reports and an analytic approach set forth in a previous Bulletin article.1 That risk measure which relies on relatively small amounts of data and requires simplifying assumptions suggests that the interest rate risk exposure for the vast majority of the banking industry is not signi cant at present. This article also attempts to gauge the reliability of the simple measure s results for the banking industry by comparing its estimates of interest rate risk exposure for thrift institutions with those calculated by a more complex model designed by the Of ce of Thrift Supervision. The results suggest that this relatively simple .