Interest rate risk in french banking

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Interest rate risk in the French banking system
General Secretariat of the Commission bancaire International Affairs Division

General Secretariat of the Commission bancaire Banking Studies Division

Although most bank failures and banking problems historically have been attributable to poorly managed exposures to credit risk, inadequate management ofinterest rate risk can give rise to the same types of problems, as illustrated by the U.S. 'savings and loan crisis' of the early 1990s. Interest rate risk is one of the principal risks inherent in the maturity transformation activity of banks. Excessive or poorly managed exposure to interest rate risk can menace both the financial balance of specific credit institutions and the overall stability ofthe financial system. The current environment of low interest rates, ongoing developments in regulatory and accounting standards, and the structural burden of the fixed-rate investment strategy of French banks – and of continental European banks in general – all combine to make exposure to and management of interest-rate risk a leading concern of the different actors involved in ensuring financialstability. In this environment, prudential authorities, along with other authorities responsible for overall financial stability, need to have accurate indicators of levels and trends in exposure to interest rate risk in the financial system. However, the diversity of this risk makes it very difficult to select such indicators. The choice depends heavily on the nature of the interest rate risk –in particular, on the volume of assets and liabilities containing embedded options –, on the financial structure of the specific institution, and on its overall strategy. This explains the diversity of practices observed today in the monitoring and management of interest rate risk. The same factors also make it extremely difficult to establish a harmonised system of quantitative reporting. As withother types of risk, the first line of defense against the vulnerabilities associated with interest rate risk is the soundness and robustness of internal management and control systems. The new capital framework envisages a tailored supervisory review.

Banque de France • Financial Stability Review • No. 6 • June 2005


Interest rate risk in the French banking systemariations in interest rates can have profound microeconomic and macroeconomic consequences. Understanding how these consequences affect financial intermediaries is of central importance in reaching an overall assessment of financial stability. The development of analytic tools and quantitative standards for measuring and regulating overall risk exposure, like those that have proved useful in assessingother types of banking risk, is rendered extremely difficult, if not impossible, by the close link between the measure of interest rate risk and the particular financial characteristics (type of activity, method of financing) and financial strategies (hedging of exposures, voluntary position-taking) of each credit institution. Because the measurement of interest rate risk depends on the specificcharacteristics of each institution, it does not lend itself to uniform treatment. Nevertheless, the significance of this risk for individual credit institutions, and its potential systemic consequences for the economy as a whole, calls for bank supervisors, and indeed all authorities responsible for financial stability, to examine these questions very closely. The concern of regulators is heightenedby current developments in the financial environment and by changes in regulatory and accounting standards which are likely to increase the sensitivity of certain institutions to interest rate risk (section 1). In order to assess the exposure of the French banking system to interest rate risk, the General Secretariat of the Banking Commission surveyed seven large banking groups1 during the...