Be vigilant against Interest rate risk, FM tells banks

Subject: Economy

Section: Monetary policy

Concept :

Amid fears of contagion effects from banking crises in the U.S. and Europe, Finance Minister Nirmala Sitharaman has asked banks to remain vigilant about “interest rate risks” and undertake regular stress tests, even as public sector bankers assured her all possible steps are being taken to safeguard themselves from any potential financial shock.
Sitharaman, also urged banks to try attracting more deposits now that the government has reduced “the tax arbitrage in some debt instruments”, hinting at the Finance Bill changes to strip some of the tax benefits that are available to debt mutual funds from April 1.

Interest Rate Risk

Interest rate risk is the exposure of a bank’s current or future earnings and capital to adverse changes in market rates.
Interest rate risk is the potential for investment losses that can be triggered by a move upward in the prevailing rates for new debt instruments.
If interest rates rise, for instance, the value of a bond or other fixed-income investment in the secondary market will decline.
The change in a bond’s price given a change in interest rates is known as its duration.
Interest rate risk is measured by a fixed income security’s duration, with longer-term bonds having a greater price sensitivity to rate changes.
Interest rate risk can be reduced through diversification of bond maturities or hedged using interest rate derivatives.