INTEREST RATE RISK
What is Interest Rate Risk? It is the risk which alters the risk, in the interest rates and thus results in reduction of market value of a bond or other securities. Also, it can be referred to be a part of Market rate risk. Here the risk factor increases, as the period of bond/security increases.
Economy Value of Equity:
EVE is the value of the bank’s assets and liabilities which are directly linked to the interest rates. By calculating the EVE of the Assets and Liabilities, banks are able to build a model which shows the real effect of the changes on the total Capital held.
RBI has released the guidelines on IRRBB (Interest Rate Risk in Bank Books). IRRBB refers to the existing or the future risk on the bank’s capital and earnings which arises due to fluctuation in interest rates, which again ultimately affects the bank’s books. Thus, an excessive IRRBB position would ultimately result in affecting the bank’s Capital Base and also the current and future interest earnings. Hence it is necessary to manage the same correctly.
CHANGES IN EVE
Therefore RBI has suggested that Banks should effectively compute and disclose any changes in the EVE and also changes in their interest income. Thus the guideline adds that if the Economic Value of the Equity goes above 15% of the core Tier I capital, banks should take appropriate measures to adjust the capital, in line with the Pillar 2 guidelines of BASEL III regulations.