The integrated impact of credit and interest rate risk on banks

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 10 January 2008

Working Paper No. 339
By Mathias Drehmann, Steffen Sorensen and Marco Stringa

Credit and interest rate risk in the banking book are the two most important risks faced by commercial banks. In this paper we derive a consistent and general framework to measure the integrated impact of both risks on banks' portfolios. The framework accounts for all sources of credit risk and interest rate risk. By modelling the whole portfolio of a bank and by taking account of the repricing characteristics of all exposures, we can assess the impact of credit and interest rate risk not only on the bank's economic value but also on its future earnings and capital adequacy. We apply our framework to a hypothetical bank in normal and stressed conditions. The simulation highlights that it is fundamental to measure the impact of interest rate and credit risk jointly. We also show that it is crucial to model the whole portfolio, including the repricing and maturity characteristics of assets, liabilities and off balance sheet items.

PDFThe integrated impact of credit and interest rate risk on banks: an economic value and capital adequacy perspective

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