Nonmaturity deposits and banks’ exposure to interest rate risk: issues arising from the Basel regulatory framework

Rosa Cocozza and Domenico Curcio and Igor Gianfrancesco

Journal of Risk

Abstract: ABSTRACT Because publicly available measures of deposit runoff risk are scarce, regulators' models to measure interest rate risk in the banking book are based on very coarse assumptions about the allocation of nonmaturity deposits within the regulatory maturity ladder. Using well-established statistical approaches, we address this issue by developing a methodology that considers deposits' actual behavior in terms of both price sensitivity to changes in market rates and volume stability over time. Our model extends the current knowledge of public measures of interest rate risk and can be applied to publicly available data in a manner replicable by those outside of banking institutions. The use of different allocation criteria affects not only the size of the risk indicator but also the nature of banks' risk exposure and determines the risk inversion phenomenon, that is, banks exposed to an increase in interest rates can experience a reduction in their equity economic value if interest rates decrease. Overall, our results confirm the importance of accurate modeling of nonmaturity deposits for estimating interest rate risk in the banking book.

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