How Do Banks Manage Interest Rate Risk?
Matching Assets and Liabilities Interest rate risk is the difference in time, credit, and rate between an asset and the liability used to fund the asset. In the case of a bank, the primary liability is its deposit base, the certificates of deposits it issues and savings accounts, among other items. Certificates of deposit and savings accounts are interest-rate sensitive items for which the bank must be prepared to offer competitive rates. The deposit pool is a function of the size of the bank. Banks are continually adjusting the optimum number of outstanding liabilities and the maturity structure based on the amount of new loans made each day. The issue of what structure the maturity of liabilities must be is also important because the bank must be ready for immediate line of credit commitments. These are agreements that banks hold with individuals and businesses to prearrange lending if needed. These agreements are usually written for a fee and a 1-year time frame. The funding is vari
