Commercial Bank Risk: Market, Interest Rate, and Foreign Exchange

Abstract

Because of recent structural changes in the balance sheets of banks, regulatory changes in the risk-based capital requirements, and the recent adoption of mark-to-market accounting changes, interest rate risk remains an important issue for commercial banks and an important regulatory concern. Market, interest rate, and foreign exchange risk are estimated for a sample of commercial banks using ordinary least squares from 1986 to 1991. Consistent with earlier studies, the estimated coefficients continue to be unstable. We find that interest rate risk decreases and foreign exchange risk increases. Moreover, the results differ depending on practices of the bank (money center, superregional, or regional). We find evidence consistent with earlier studies that theorize foreign exchange risk is explained by unhedged foreign loan exposure.

The Impact of Exchange Rates and Interest Rates on Bank Stock Returns: Evidence from U.S. Banks

“…They find that interest rate and exchange rate sensitivity vary in both relatively stable and volatile interest rate periods. Wetmore and Brick (1994) use the model by Choi et al, (1992) and find that the coefficients of market risk, interest rate risk, and foreign exchange risk vary with time. Tai (2000) investigates the role of market, interest rates, and exchange rates in pricing bank stock returns by using three different econometric methodologies.…”

“…Another major concern amongst investors, banking authorities, academicians and policy makers are the volatility of the financial markets and its impact on interest rate changes of bank stocks. This in turn has led to several researches examining the effect of interest rate on bank stock returns using a two-index market model assuming of constant variance (Stone 1974, Lloyd and Shick 1977, Chance and Lane 1980, Lynge and Zumwalt 1980, Flannery and James 1984, Booth and Officer 1985, Scott and Peterson 1986, and Bae 1990); a few studies examining interest rate sensitivity of bank stock returns under time-varying conditions (Kane and Unal 1988, Kwan 1991, Choi et al, 1992, and Wetmore and Brick 1994. Some other studies by show that bank stock returns are more sensitive to changes in long-term interest rates than to changes in short-term interest rates (Akella andChen, 1990 andElyasiani, 1995).…”

“…A very few studies examine the joint interaction between exchange rates and interest rates on bank stocks returns (Choi et. al.,1992, Wetmore and Brick 1994, Tai, 2000and Kasman et. al., 2011.…”

Derivative activities and Chinese banks’ exposures to exchange rate and interest rate movements

“…The official rate for the US$ was adjusted to 1.56 RMB, 2.94 RMB, 5.76 RMB and 8.62 RMB in 1979, 1993and 1994 In 1994 regime is still heavily managed at present, it tends to be much more volatile than before.…”

“…We use a GARCH-based multifactor model with time varying parameters to allow banks' exchange rate and interest rate exposures to vary over time 2 . Secondly, we argue that the capital market approach used by past empirical studies, such as Choi et al (1992), Wetmore and Brick (1994) and Choi and Elyasiani (1997), only measures the bank's foreign exchange and interest rate risks over and above that of the market portfolio. To estimate the bank's total exposure to the foreign exchange rate and interest rate movements, we use orthogonalised, rather than actual, market returns to measure the time varying exposure of Chinese banks…”