An Analysis of Commercial Bank Exposure
to Interest Rate Risk
David M. Wright and James V. Houpt, of the Board’s
Division of Banking Supervision and Regulation, pre-
pared this article. Leeto Tlou and Jonathan Hacker
provided assistance.
Banks earn returns to shareholders by accepting and
managing risk, including the risk that borrowers may
default or that changes in interest rates may narrow
the interest spread between assets and liabilities. His-
torically, borrower defaults have created the greatest
losses to commercial banks, whereas interest margins
have remained relatively stable, even in times of high
rate volatility. Although credit risk is likely to remain
the dominant risk to banks, technological advances
and the emergence of new financial products have
provided them with dramatically more efficient ways
of increasing or decreasing interest rate and other
market risks. On the whole, these changes, when
considered in the context of the growing competition
in financial services have led to the perception among
some industry observers that interest rate risk in
commercial banking has significantly increased.
This article evaluates some of the factors that may
be affecting the level of interest rate risk among
commercial banks and estimates the general magni-
tude and significance of this risk using data from the
quarterly Reports of Condition and Income (Call
Reports) and an analytic approach set forth in a
previous Bulletin article.1 That risk measure, which
relies on relatively small amounts of data and
requires simplifying assumptions, suggests that the
interest rate risk exposure for the vast majority of the
banking industry is not significant at present. This
article also attempts to gauge the reliability of the
simple measure’s results for the banking industry by
comparing its estimates of interest rate risk exposure
for thrift institutions with those calculated by a more
complex model designed by the Office of Thrift
Supervision. The results suggest that this relatively
simple model can be useful fo