CAIIB Paper 2 Module D Quiz 5

IRRBB arises because interest-rate changes affect the value and/or earnings of banking-book assets, liabilities and off-balance-sheet items. It includes repricing, basis, yield-curve and option-related effects.

Repricing gap = rate-sensitive assets minus rate-sensitive liabilities = ₹500 crore − ₹650 crore = −₹150 crore. The negative gap indicates more liabilities than assets reprice in that bucket.

A positive gap can benefit near-term net interest income when rates rise because more assets than liabilities reprice upward. The result is only indicative and depends on pass-through, timing, basis and customer behaviour.

With more rate-sensitive liabilities than assets, rising rates can increase interest expense more than interest income in the relevant horizon. Actual impact depends on repricing lags, administered rates and behavioural assumptions.

Basis risk occurs when assets and liabilities reference different indices or rates whose movements are imperfectly correlated. Even if both reprice, their spread may change and affect earnings.

Interest rates at different maturities may move by different amounts. Changes in curve slope or shape affect positions with different maturities and can alter both economic value and earnings.

Borrowers may prepay when rates fall, while depositors may withdraw or change products as rates move. These embedded options make cash flows behaviourally dependent on interest rates.

The earnings perspective estimates how interest-rate changes affect net interest income and, in broader approaches, earnings over a specified horizon. It is distinct from the economic-value perspective.

Economic value analysis discounts expected cash flows and assesses how rate shocks change their present value. It captures longer-term value effects that may not be visible in short-horizon NII measures.

A basic gap model aggregates positions into buckets and may miss within-bucket timing, basis risk, yield-curve shifts, optionality and economic-value effects. It is useful but not a complete risk measure.

A parallel shift applies the same absolute rate change across maturities. Real market movements are often non-parallel, so banks should also consider other curve scenarios.

Macaulay duration is the weighted average time of cash flows, with weights based on present values. Modified duration is commonly used to estimate price sensitivity to yield changes.

Approximate percentage price change ≈ −modified duration × change in yield. Thus −4.5 × 0.01 = −4.5%. The estimate is local and ignores convexity and other effects.

When asset duration exceeds liability duration on a suitably weighted basis, asset values may fall more than liability values as rates rise, reducing economic value of equity. The exact result depends on the duration-gap definition and balance-sheet structure.

Duration gives a first-order linear approximation. Convexity captures curvature and can improve price-change estimates for larger yield changes, although actual outcomes also depend on cash flows and embedded options.

A floor creates asymmetric repricing: below the floor, the customer rate may not track further benchmark declines. Such optionality can change asset yields and should be reflected in risk measurement.

Administered rates may be adjusted discretely and not move one-for-one with market rates. This can create timing and basis differences between asset yields and funding costs.

A range of parallel and non-parallel interest-rate shocks helps capture different yield-curve movements. Banks should select scenarios relevant to their exposures and applicable supervisory expectations.

Hedges can reduce exposure but may introduce basis, counterparty, valuation and operational risks. Effectiveness depends on matching key cash-flow, tenor, index and optionality characteristics.

Sound management requires governance, suitable measurement systems, documented assumptions, independent review, limits, stress testing and timely management reporting.