Measurins Interest Rate Risk in Indian Banks

Abstract

Banking and financial system are the backbone of any economy. Assets and Liabilities Management (ALM) of banks is a dynamic process of planning, organizing, coordinating and controlling the assets and liabilities - their mixes, volumes, maturities, yields and costs in order to achieve a specified Net Interest Income (Nil). The N il is the difference between interest income and interest expenses and the basic source of banks' profitability. Banks are always aiming at maximizing profitability at the same time trying to ensure sufficient liquidity. Should there be any disorderly adjustments in the financial markets, it may have implications for the banking sector through changes in interest rates and liquidity shifts. Sharp rise in interest rates may result in marked to market losses on the investment portfolio of banks. This concept has gained importance in Indian conditions in the wake of the ongoing financial sector reforms, particularly reforms relating to interest rate deregulation. The technique of managing both assets and liabilities together has come into being as a strategic response of banks to inflationary pressure, volatility in interest rates and severe recessionary trends which marked the global economy in the seventies and eighties. The major focus of prudential regulation in developing countries has traditionally been on credit risk. While banks and their supervisors have grappled with non-performing loans for several decades, interest rate risk is a relatively new problem. Admmistrative restrictions on interest rates in India have been steadily eased since 1993. This has led to increased interest rate volatility. Hence, there is a need to measure the interest rate risk exposure ofhidian banks. This paper entitled Measuring Interest Rate Risk in Indian Banks measures the Interest Rate Risk exposure of State Bank of India (SBI), by using Gap Analysis Technique. Using publicly available information, this paper attempts to assess the interest rate risk carried by the SBI in 2006, 2007, and 2008. Key Words— Interest volatility, Interest Rate Risk, Indian Banks, SBI. Introduction Banks have twin objectives of maximizing profitability and at the same time trying to ensure sufficient liquidity. To achieve these objectives, it is essential that banks have to m onitor, maintain and m anage their assets and liabilities portfolios in a systematic m anner taking into account the various risks involved in these areas. This concept has gained importance in Indian conditions in the wake of the ongoing financial sector reforms, particularly reforms relating to interest rate deregulation. Journal of Accounting and Finance Volume 24, No. 1 October 2009-March 201 O Measuring Interest Rate Risk in Indian Banks Dr. B. Charumathi Abstract Banking and financial system are the backbone of any economy. Assets and Liabilities Management (ALM) of banks is a dynamic process of planning, organizing, coordinating and co11trolli11g the assets and liabilities - their mixes, volumes, maturities, yields and costs in order to achieve a specified Net Interest !llcome (NII). The NII is the difference between interest income and interest expenses and the basic source of banks' profitability. Banks are always aiming at maximizing profitability at the same time trying to e11s11re s11fficient liq11idity. Should there be any disorderly adj11stments in tire financial markets, it may have implications for the banking sector thro11gh changes i11 interest rates and liq11idity shifts. Sharp rise ill interest rates may result in marked to market losses Oil the investment portfolio of ba11ks. This concept has gained importance in Indian conditions in the wake of tire ongoing financial sector nforms, particularly reforms relating to interest rate dereg11lation. The technique of 11w1ia:,?in:,? both assets and liabilities together has come into being as a strategic response of banks to inflationary pressure, volatility in interest rates and severe recessionary trends which marked the global economy in the seventies and eighties. The major focus of prudential regulation in deiieloping co11 ntries has traditionally been on credit risk. While ballks and their supervisors have grappled with llo11-performi11g loans for several decades, interest rate risk is a relatiiiely new problem. Admmistratiiie restrictions 011 interest rates ill India hac1e bee11 steadily eased si11ce 1993. This has led to increased interest rate iiolatility. l-lence, there is a need to measure the interest rate risk exposure of Indian banks. This paper e11titled Measuring Interest Rate Risk in Indian Banks meas11res tire Interest Rate Risk expos11re of State Bank of India (SBI), by 11si11g Gap Analysis Techniq11e. Using p11blicly available i11formatio11, this paper attempts to assess the interest rate risk carried by the SBI in 2006, 2007, and 2008.imizing profitability at the same time trying to ensure sufficient liquidity.