Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition

Reporting risk

In the above example, a change of 1% was used to keep the mathematics simple, but in reality you should consider what could be a potential rate change: 1% or 5%? Obviously the earnings-at-risk would be much larger for a 5% rate change.

To answer this question, the ALCO must first answer the following question: If interest rates start to move in the wrong direction, the treasury will not stay idle and take the loss, but instead it will take action to close the gap. How much time will be needed to close the position: a day or a week? This time interval, referred to as the holding or defeasance period, is important as interest rates are not likely to move much over a very short period, but could move much more over a longer period. ...