Risk ; Interest rates ; Banks and banking ; Banks and banking - West ; Federal Reserve District, 12th

Jonathan A. Neuberger

English

Research Papers in Economics

FRBSF WEEKLY LETTER
Number 93-26, July 23, 1993
Interest Rate Risk at
U.5. Commercial Banks
During the past few years, the composition of
u.s. commercial banks' asset portfolios has
changed dramatically. Most notably, holdings of
securities have grown over 35 percent since the
beginhing of 1990, while loans to businesses
have actually declined over the same period.
Some observers argue that if increases in bank
securities holdings are concentrated in longer-
term issues, then these portfolio shifts may
expose banks to increased interest rate risk,
especially if rates rise rapidly.
Unfortunately, it is difficult to assess the interest
rate risk exposure of the banking system without
detailed information on the maturity and cash
flow characteristics of bank assets and liabilities.
Federal banking agencies have proposed systems
to measure this risk, but the data needed to de-
rive these measures are not yet available.
In this Weekly Letter, I provide a preliminary as-
sessment of the interest rate risk of u.s. commer-
cial banks using data that are currently available
in bank Call Reports. While the measure I derive
is incomplete, it does suggest that some of the
concerns about bank interest rate risk may be
overstated.
Methodology and assumptions
As part of an ongoing effort to assess bank inter-
est rate risk, the Federal Reserve Board has pro-
posed a risk measurement system that is to be
implemented beginning in 1994. Under this pro-
posal, banks will provide detailed data on the
maturity and cash flow characteristics of their as-
sets and liabilities. Based on these features, one
set of risk weights will be assigned to liabilities,
and one set will be assigned to each of three cat-
egories of assets: amortizing, nonamortizing, and
deep discount. Holdings in each category will be
multiplied by the appropriate risk factor, which
represents the change in the value of the bank's
position in that category that would result from a
shock to interest rates. Netting risk-weighted as-
sets against risk-weighted liabilities, regulators
can determine how much a bank's net worth
would change in response to a given parallel
shift in interest rates. Under the Fed's proposal,
banks may be required to hold more capital
against interest rate risk if their risk exposure is
considered to be "excessive:' (For a more de-
tailed description of an earlier, but similar, inter-
est rate risk measure, see Weekly Letter 92-39.)
My measure of bank interest rate risk is based
on the March 1993 version of the Fed's proposed
methodology. However, several compromises
were required because banks currently do not
report sufficient information to derive the Fed's
interest rate risk measure. First, limited maturity
data are available from 1988.Q4 on bank hold-
ings of fixed and floating rate loans, securities,
and large CDs in each of four time-to-maturity
bands. The Fed's proposed risk measure uses
seven time bands. These data are the basis for
my interest rate risk calculations.
Second, banks donot currently includedata on the
cash flow characteristics oftheir assets. However,
whether a loan amortizes or not can significantly
affect its interest rate risk. In addition, other char-
acteristics, like prepayment options and interest
caps on mortgages, also affect the interest rate
sensitivityofthese assets. To deal with these issues,
it was necessary to make several assumptions.
First, Iassume thatall real estate and personal loans
are amortizing, while loans for construction and
land development, business loans, and loans to
other banks are not. I then calculate the propor-
tion of total loans that are amortizing and non-
amortizing, and apply these percentages to each
of the four loans-by-maturity categories. For se-
curities, I assume that mortgage-backed securities
are amortizing, while all others are not and again
WESTERn BAnKinG Western Banking is a quarterly review of banking
developments in the Twelfth Federal Reserve District. It is published in the Weekly Letter on the fourth
Friday ofJanuary, April, July, and October.Net Risk-Weighted Position
as a Percent of Total Assets
(+200 basis point shock to interest rates)
bank net worth resulting from the 200-basis-
point rise in all interest rates, divided by total
bank assets. Thus, a value of 1.0 would indicate
that a 200-basis-point increase in rates \vQu!d re~
duce bank net worth by 1 percent of assets. The
results of this calculation are presented in the fig-
ure for the period from 1988.Q4 to 1993.Q1.
According to this measure, the interest rate risk
exposure of u.s. banks' on-balance sheet ac-
tivities is 0.85 percent of assets as of early 1993.
Since some interest rate risk is inherent in bank-
ing, this exposure does not seem "excessive:'
In fact, the Fed has suggested that interest rate
risk below 1 percent of assets is within industry
norms. The data suggest that interest rate risk
among banks as a group has not increased much
in recent years. In fact, the figure shows a slight
downward trend in interest rate risk since
mid-1990.
1992 1991 1990 1989
Thus, there is evidence that recent portfolio shifts
at u.s. banks have not resulted in an increased
exposure to interest rate risk. This conclusion
comes with two caveats. First, aggregation of
individual bank balance sheets may conceal in-
creases in interest rate risk at individual banks.
While the figures for the industry as a whole indi-
cate no real systematic shift in interest rate risk
among banks, this does not preclude jumps in
interest rate exposures at individual institutions.
Second, the results presented here omit bank off-
balance sheet activities. A betterassessmentofthe
risk-enhancing or risk-reducing effects of these
activitieswill have to awaitthe availability ofbetter
data from the banking system.
Jonathan A. Neuberger
Economist
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1993
The maturity of deposits is an important issue in
determining bank interest rate risk. Deposits with
no specific maturity, such as checking and sav-
ings accounts, can be thought to have very short
maturity since they can be withdrawn on de-
mand. At the same time, however, these deposits
are a stable funding source for banks whose rates
adjust slowly. Thus, they may have an effective
maturity that is quite long. The Fed's proposal
gives banks some freedom to allocate their lia-
bilities across the different maturity bands, with
guidelines to limit the proportion of deposits in
the longer time bands. I follow the proposed
guidelines in determining the maturities of bank
deposits and other liabilities.
apply these percentages to the maturity data. The
effects of prepayments and other imbedded op-
tions are incorporated in the risk-weights pro-
posed by the Fed. In the absence of additional
information, I also assume that banks hold no
deep-discount assets.
Finally, the measure I derive does not include
data on off-balance sheet activities. Unfortu-
nately, there are no data to characterize bank's
off-balance sheet activities or to determine their
maturities. While some argue that off-balance
sheet positions pose considerable interest rate
risk, others suggest that banks use these activities
to hedge against interest rate risks in other posi-
tions. The net effect of this omission, therefore,
is uncertain.
For the risk weights, I use the risk factors in the
Fed's most recent proposal. The four time bands
for which data are currently available do not
match up exactly with the seven bands in the
Fed proposal. For the medium-term instruments
(1 to 5 years), I use the 3-to-5-year proposed risk
weight; for my over 5-year maturity band, I use
the Fed's 1O-to-20-year risk weight.
Results
Using the methodology described above, !esti-
mate the effect on the u.s. commercial banking
system of a 200-basis-point across-the-board
increase in interest rates. While the effect of in-
terest rate changes would differ if rates rose less
or if they fell, this scenario addresses the effect of
a large unanticipated positive shock to all inter-
est rates. The interest rate risk measure is the net
risk-weighted position, defined as the change in
FRBSFREGIONAL BANK DATA
MARCH 31, 1993
(NOTSEASONALLYADJUSTED, PRELIMINARY DATA)
DISTRiCT ALASKA ARIZ. CALIF. HAWAII IDAHO NEVADA OREGON UTAH WASH.
FOREIGN (RESIDUAL) 28,927 0 0 28,438 2,393 0 0 0 64 32
DOMESTIC 461,520 4,643 35,692 297,738 19,865 10,128 13,641 25,247 14,358 40,008
LOANS TOTAL 328,652 2,273 19,808 223,699 13,792 6,756 7,234 17,153 8,440 29,497
FOREIGN (RESIDUAL) 28,036 5 0 26,644 1,335 0 0 0 0 52
DOMESTIC 300,616 2,268 19,808 197,054 12,458 6,756 7,234 17,153 8,440 29,445
REAL ESTATE 159,749 1,071 6,978 116,483 7,303 2,129 2,412 7,073 3,307 12,992
COMMERCIAL 62,024 716 2,677 39,235 3,261 1,505 802 4,465 1,615 7,747
CONSUMER 53,846 350 6,014 27,481 1,076 2,041 3,879 3,530 2,779 6,696
AGRICULTURE 5,308 4 318 2,803 30 626 12 397 151 967
INTERNATIONAL 85 0 8 77 0 0 0 0 0 0
SECURITIES TOTAL 74,301 1,995 8,645 40,423 5,049 2,036 3,825 4,401 3,636 4,290
U.S.T.S. 24,082 875 2,738 11,842 2,817 463 1,676 1,387 835 1,451
SECONDARY MARKET 38,526 613 4,975 23,193 1,710 910 1,719 2,158 1,817 1,430
OTHER SEC. 11,693 508 934 5,388 622 663 429 856 985 1,409
LIABILITIES TOTAL 448,153 4,226 32,305 297,278 20,609 9,376 12,002 22,883 13,109 36,365
DOMESTIC 419,220 4,226 32,305 270,835 18,215 9,376 12,002 22,883 13,046 36,333
DEPOSITS TOTAL 394,477 3,543 29,340 265,750 14,794 7,787 9,571 20,181 10,522 32,990
FOREIGN (RESIDUAL) 26,781 0 0 24,498 2,188 0 0 0 64 32
DOMESTIC 367,696 3,543 29,340 241,252 12,606 7,787 9,571 20,181 10,458 32,958
DEMAND 88,812 997 5,915 61,820 2,352 1,358 2,475 3,966 2,111 7,818
TIME AND SAVINGS 278,884 2,545 23,425 179,432 10,254 6,429 7,096 16,216 8,346 25,139
NOW 41,200 330 3,434 24,508 1,479 1,017 1,289 3,194 1,490 4,460
MMDA 94,076 538 7,582 65,902 1,939 1,590 2,370 4,358 1,776 8,021
SAVINGS 44,735 689 3,407 27,193 3,126 991 1,572 2,206 1,688 3,864
SMALL TIME 68,030 444 7,528 39,464 2,065 2,239 1,045 5,517 2,693 7,035
LARGE TIME 30,656 507 1,475 22,291 1,642 592 819 935 698 1,697
OTHER BORROWINGS 31,979 639 2,396 14,143 5,215 1,427 1,357 2,136 2,334 2,332
EQUITY CAPITAL 42,293 617 3,387 26,897 1,649 751 1,639 2,364 1,312 3,675
LOAN LOSS RESERVE 10,204 40 556 7,599 240 108 400 450 198 613
LOAN COMMITTMENTS 196,628 660 28,638 121,232 8,297 3,279 1,941 10,231 7,135 17,214
LOANS SOLD 15,630 25 153 14,805 228 25 68 190 51 86
11 ,228 103 743 7,309
INTEREST 8,495 84 585 5,564 377 179 283 449 257 718
FEES & CHARGES 735 6 57 492 12 14 16 47 22 70
EXPENSES TOTAL 9,212 72 662 6,130 334 162 420 482 251 699
INTEREST 2,809 24 209 1,811 154 69 72 145 90 235
SALARIES 2,330 24 169 1,589 85 32 53 144 54 181
LOAN LOSS PROVISION 846 2 48 628 16 5 86 21 12 28
OTHER 3,227 22 236 2,102 80 56 209 171 95 256
INCOME BEFORE TAXES 2,016 31 81 1,179 85 49 152 139 75 214
TAXES 780 9 28 495 34 18 51 49 25 70
NETINCOME 1,277 21 40 765 86 26 98 80 46 135
ROA(%) 1.05 1.81 0.45 0.94 1.17 1.08 2.95 1.28 1.32 1.35
ROE(%) 12.08 13.82 4.74 11.37 15.94 14.07 23.90 13.55 14.03 14.69
NETINTEREST MARGIN (%) 4.66 5.09 4.25 4.63 3.98 4.42 6.37 4.86 4.79 4.85
LOAN LOSS RESERVE (ALL BANKS) 3.10 1.77 2.81 3.40 1.74 1.61 5.52 2.62 2.08
NETCHARGEOFFS, TOTAL 1.00 0.23 0.74 1.19 0.16 0.18 2.88 0.55 0.18 0.34
REAL ESTATE 0.79 -0.08 0.28 1.01 0.09 0.01 0.30 0.38 0.15 0.18
COMMERCIAL 0.41 0.54 0.57 0.49 0.13 0.07 5.29 0.11 -0.70 -0.13
CONSUMER 2.91 0.57 1.83 4.08 0.76 0.49 3.95 1.68 0.77 1.12
AGRICULTURE -0.02 0.00 0.52 -0.15 0.00 0.15 -0.09 -0.13 -0.11 0.12
PASTDUE & NON-ACCRUAL, TOTAL 5.57 2.90 4.13 6.48 3.35 1.93 7.41 2.43 1.97 4.13
REAL ESTATE 7.30 3.05 6.64 8.32 3.44 2.43 8.88 2.47 2.65 5.37
CONSTRUCTION 20.65 3.35 18.85 23.17 11.82 9.29 22.67 5.13 3.01 17.72
COMMERCIAL 7.59 3.02 11.66 8.98 1.33 2.43 7.46 3.35 3.47 3.21
FARM 8.49 0.00 20.57 9.19 11.33 3.37 0.00 5.59 10.85 2.73
1-4 FAMILY REV' 1.13 1.14 0.59 1.20 1.51 0.51 0.50 0.33 0.68 1,18
1-4 FAMILY OTHER 3.05 2.28 2.54 3.42 3.72 1.17 3.49 0.98 1.31 1.34
MULTI-FAMILY 8.18 1.17 10.90 9.70 1.13 0.74 27.13 0.92 0.18 2.83
COMMERCIAL 5.46 2.59 6.39 6.12 4.04 1.47 13.31 2.39 2.43 3.86
CONSUMER 3.34 2.39 2.70 3.90 2.49 1.39 5.78 1.69 1.04 2.59
AGRICULTURE 5.62 0.00 8.01 5.88 26.88 4.50 4.21 5.42 1.88 4.39
NUMBER OF BANKS 742 8 38 447 17 20 18 48 54 92
NUMBER OF EMPLOYEES 245,225 2,676 19,505 159,606 8,474 4,652 6,212 16,234 7,159 20,707
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, orof the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor orto the author...• Free copies of Federal Reserve publications can be
obtained from the Public Information Department, Federal Reserve Bank ofSan Francisco, P.O. Box 7702, San Francisco 94120.
Phone (415) 974-2246, Fax (415) 974-3341.~ t:t\ S~UI ueaqAos 41lM
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DEPOSITORY INSTITUTIONS REQUIRED TO HOlD RESERVES WITH THE FEDERAL RESERVE ON A WEEKLY BASIS
PERCENT OF COMBINED MARKET TOTAL FOR MAY 1993. BY REGION
DISTRiCT ALASKA ARIZONA CALIF HAWAII IDAHO NEVADA OREGON UTAH WASH ---- ----
DEPOSIT TYPE CB Sl CU CB Sl CU CB Sl CU CB Sl CU CB Sl CU CB Sl CU CB Sl CU CB Sl CU CB Sl CU CB Sl CU
TOTAL DEPOSITS 55 39 7 71 4 25 92 1 7 4B 46 66 30 5 91 5 4 76 21 3 81 10 9 79 5 16 56 35 9
DEMAND 90 6 4 99 0 1 96 0 4 89 6 90 3 7 95 0 5 97 3 0 95 I 4 89 5 6 83 15 2
NOW 64 28 8 57 6 37 89 0 11 57 36 66 31 3 92 3 4 78 16 6 84 8 9 B2 2 16 66 23 11
SAVINGS & MMDAS 60 31 9 55 5 41 90 0 10 56 37 59 34 7 92 4 4 79 16 5 77 10 13 72 3 25 57 27 17
SMAll TIME 32 66 3 75 8 17 95 1 4 23 74 3 54 44 ee 11 43 53 77 17 61 11 3S 57
lARGETIME 43 47 10 96 2 3 91 0 9 37 52 11 70 23 90 5 as 15 76 12 12 73 19 44 54
CB = COMMERCIAL BANKS; Sl = SAVINGS & lOANS AND SAVING BANKS; CU _ CREDIT UNIONS; MAY NOT SUM TO 100% DUETO ROUNDING
TYPE OF ACCOUNT OR LOAN DATE US DISTRICT ARIZ CALIF HAWAII IDAHO OREGON UTAH WASH
SAVINGS ACCOUNTS AND MMDAS MAR 93 2.73 2.87 2.54 2.59 3.03 3.33 2.71 3.09 2.98
APR93 2.68 2.81 2.59 2.56 2.81 3.27 2.61 2.99 2.94
MAY 93 2.65 2.78 2.57 2.54 2.84 3.20 2.50 2.97 2.91
92 TO 182 DAYS CERTIFICATES MAR93 3.03 2.93 2.70 2.85 2.50 3.09 2.99 3.05 3.25
APR93 2.99 2.89 2.76 2.82 2.33 3.00 2.92 3.05 3.24
MAY 93 2.98 2.87 2.74 2.80 2.25 2.98 2.96 3.04 3.13
2-1/2 YEARS AND OVER CERTIFICATES MAR93· 4.52 4.34 3.83 3.95 4.16 5.08 5.01 4.39 4.48
APR 93 4.47 4.33 3.92 3.94 4.19 4.90 5.01 4.39 4.56
MAY 93 4.45 4.27 3.81 3.91 4.11 4.90 4.95 4.34 4.54
COMMERCIAL. SHORT TERM* AVE. RATE 4.80 5.20 6.72 4.92 6.69 7.37 6.49 4.97 5.61
AVE. MAT. (DAYS) 50 84 N/A 264 N/A N/A N/A 35 N/A
COMMERCIAL. LONG-TERM' AVE. RATE 8.32 9.41 N/A N/A N/A N/A N/A 8.41 N/A
AVE. MAT. (MONTHS) 42 46 N/A N/A N/A N/A N/A 48 N/A
LOANS TO FARMERS' AVE, RATE 7.52 6.72 6.56 6.63 N/A 8.07 6.82 8.71 6.90
AVE. MAT. (MONTHS) 15 14 N/A 14 N/A N/A N/A 7 N/A
CONSUMER. AUTOMOBILE AVE, RATE 8.17 8.23 8.4 7,84 N/A N/A 8.02 8.88 8.17
CONSUMER. PERSONAL AVE. RATE 13.63 13.87 15 18.19 N/A N/A 9.21 13.65 11.84
CONSUMER, CREDIT CARDS AVE, RATE 17.15 17,6 14.9 18.38 N/A N/A 19.25 14.9 18.3
SOURCES: SURVEY OF TERMS OF BANK LENDING AND TERMS OF CONSUMER CREDIT; MOST COMMON INTEREST RATES ON SELECTED ACCOUNTS.
* DATA ARE COMPOUNDED ANNUAL RATES,

Interest rate risk at U.S. commercial banks

http://www.frbsf.org/publications/economics/letter/1993/el93-26.pdf

Interest rate risk at U.S. commercial banks

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