Dr. Stephan K.H. Simon

Because banks have assets and liabilities of differing durations, they are exposed to asset liability
management (ALM) risk. Hikes in interest rates can cause losses for banks if liabilities re-price to
higher rates faster than assets and vice versa. The seminal ALM risk event of recent decades was
the US savings and loans crisis of the late 1980s. Since that crisis, most banks have greatly
improved their ALM risk management. Many have thus come to think that today they have the… Show more

Because banks have assets and liabilities of differing durations, they are exposed to asset liability
management (ALM) risk. Hikes in interest rates can cause losses for banks if liabilities re-price to
higher rates faster than assets and vice versa. The seminal ALM risk event of recent decades was
the US savings and loans crisis of the late 1980s. Since that crisis, most banks have greatly
improved their ALM risk management. Many have thus come to think that today they have the right
framework in place and ALM risk is a matter of no serious concern.
Yet recent developments undermine this rosy assessment. We believe that many European banks
are taking material ALM risks which they are either unaware of or ill-equipped to manage:
• “Behaviouralization” of the balance sheet
• Own credit spreads
• Pricing basis risk
• Low interest rates
We see the need for a material upgrade to ALM for many institutions. Analytical upgrades are a prerequisite
to this, with changes in the way that the balance sheet is characterised, projected and
stress tested under more realistic scenarios. This, however, also needs to translate into better
governance of ALM risks and clearer strategy setting for the positions that institutions are and are not
prepared to take. Given that there are plausible scenarios (that have occurred in history) that could
reduce the economic value of equity for Europe’s top 50 banks by as much as €100 BN, some of it
registering on P&L, this is a risk that deserves more attention. Show less

Problem and motivation
Bearing and transforming interest rate risk is integral role and service of financial institutions. A large number of approaches to measure and quantify the interest rate risk of financial institutions can be identified in academic economic literature. While early academic work mostly focuses on accounting-oriented net interest income, later work considers the shareholders' wealth, which can be interpreted as the NPV of all interest bearing long and short positions of… Show more

Problem and motivation
Bearing and transforming interest rate risk is integral role and service of financial institutions. A large number of approaches to measure and quantify the interest rate risk of financial institutions can be identified in academic economic literature. While early academic work mostly focuses on accounting-oriented net interest income, later work considers the shareholders' wealth, which can be interpreted as the NPV of all interest bearing long and short positions of a financial institution, as the central target function. Despite the multitude of the approaches the majority of the academic work is purely theoretic and makes normative assertions about interest rate risk of financial institutions. Samuelson (1945) and Hicks (1946) formulate positive hypotheses regarding the interest rate sensitivity of financial institutions. An extensive branch of empirical work, that tests the hypothesis of significant interest rate sensitivity with regression analyses, builds on these positive assertions. However, most of this empirical work focuses on the US market. Almost no empirical results are available for the German market. Moreover, the empirical approaches show a large variation, often resulting in a lack of comparability of the results and at the same time in ambiguity regarding the suitability of different analytic approaches. For theses reasons this work for the first time both empirically investigates the interest rate sensitivity of German financial institutions and at the same time rigorously the empirical approach along its degrees of freedom.
Summary of the results
This work investigates 4 complexes of hypotheses. First, based on conventional empirical approaches the robustness of these empirical approaches across variations is tested. Also based on conventional empirical approaches the interest rate sensitivity of German financial institutions is analyzed. These analyses are extended by the introduction of term transformation factors Show less

Economic theory postulates that financial institutions are exposed to a significant interest rate risk which is largely due to their engagement in maturity transformation. Although this maturity transformation and the associated risk is of interest to all stakeholders of financial institutions, it has not yet been well studied. In this study we systematically examine different regression approaches for externally quantifying the exposure to interest rate risk of financial institutions. In this… Show more

Economic theory postulates that financial institutions are exposed to a significant interest rate risk which is largely due to their engagement in maturity transformation. Although this maturity transformation and the associated risk is of interest to all stakeholders of financial institutions, it has not yet been well studied. In this study we systematically examine different regression approaches for externally quantifying the exposure to interest rate risk of financial institutions. In this context, we have derived and empirically apply a new and - in economic respects more appropriate - maturity transformation factor. Comparing the explanatory power of different interest rate factors, this maturity transformation factor proves superior. Furthermore, this innovative factor allows us to estimate and interpret the maturity transformation of financial institutions and its respective contribution to total return and risk. All in all, the results obtained for the financial services sector in contrast to non-financial services sectors strongly support Hicks' liquidity preference hypothesis. Show less