Asset-Liability and Liquidity Management

CHAPTER 9Net Interest Income

In traditional banking, interest income plays the most prominent role in banks' revenues. On the liability side, banks use different borrowing channels to fund their lending and trading activities, and the interest expense associated with these borrowings constitutes a major portion of banks' costs. Net interest income (NII) is the net value of interest income and interest expense during a specific time horizon. One of the main objectives in asset-liability management is to set and maintain a balance sheet that ensures that the net interest income is within certain limits, either implied by the target return on equity or specifically set by the bank's management team. Using net interest income scenario analysis the bank can assess its ability to continue a profitable operation under different market conditions. Stable earnings help the bank to pay a relatively constant level of dividends and keep a stable capital position. Analyzing the contribution of net interest income to the net income of the bank and studying the impact of potential changes in market conditions on net interest income are integral parts of asset-liability management.

Generally, there are three approaches for net interest income analysis:

1. In the first approach, a runoff view of the balance sheet is considered where positions are matured and amortized based on their maturity dates or amortization schedules as of the analysis date and new positions are assumed only to the extent ...