Summary

Steering a bank through different interest rate environments is an important task, guided by the policies set by the board of directors. These include a funds management or asset liability management policy, which includes risk tolerances that maintain earnings and protect capital as interest rates change. The policies should also include a reporting mechanism for the directors, so that the board may monitor the bank’s sensitivity to market risk and compliance with established policy.

Banks may use models to assess their earnings and capital vulnerability to changes in interest rates. EAR models provide a short-term perspective on a bank’s net interest income and bottom-line profitability. Capital-at-risk models provide a long-term view on its capital exposure. The two approaches to risk measurement complement one another and can be viewed as two sides of the interest rate risk coin.