What Is Sensitivity to Market Risk?

Sensitivity to market risk reflects the degree to which changes in interest rates, foreign exchange rates, commodity prices or equity prices can adversely affect a financial institution’s earnings or economic capital. For some large institutions, foreign operations can be a significant source of market risk. Trading activities, where the institution buys and sells investment securities or foreign currencies hoping to profit on price movements, also can be a significant source of market risk for some. For most institutions, however, the primary source of market risk stems from interest rate changes and their effects on bank earnings and capital. It is this aspect of market risk that is the focus here.

This lesson reviews your bank’s exposure to interest rate changes and discusses how interest rate changes can affect bank earnings and capital and the need to establish controls over a bank’s interest rate risk-taking. Additionally, it describes tools to monitor bank interest rate exposure and discusses matters to consider when reviewing output from these tools.

Lesson Objectives

After you complete this lesson, you should be able to:

  1. define sensitivity to market risk,
  2. recognize sources of interest rate risk and
  3. identify the critical components of the earnings-at-risk and capital-at-risk models.