NET INTEREST INCOME (NII), NET INTEREST MARGIN (NIM) AND THE MANAGEMENT OF INTEREST‐RATE RISK IN THE BANKING BOOK

This chapter considers behaviour and characteristics of net interest income (NII) and net interest margin (NIM), before moving on to key principles of interest-rate risk in the banking book management. Excessive interest-rate risk can pose a significant threat to a bank's current capital base and/or future earnings if not properly managed. There are a number of different types of interest-rate risk faced by banks in their banking books: gap risk, basis risk and option risk. A static interest-rate gap report is used as a basis to assess gap risk, whether it is in relation to the effect of interest-rate movements on income (NII sensitivity) or economic value. Simulation models, adopted by some banks, can be used to assess either NII or economic value sensitivities. The chapter argues that a commercial bank seeking to run an interest-rate neutral position will aim to minimise the size of both the gaps in each repricing bucket, as well as the overall cumulative gap.