Interest rate risk measurement as a component of interest risk management in commercial banks

Banks have always faced the risk of losses in on and off-balance-sheet positions arising from undesirable market movements. The sharp increase of proprietary trading in many banks has heightened the need among regulators to ensure that these institutions have the management systems to control and the capital to absorb the risks posed by market-related exposures. But as a risk, market risk (interest rates, foreign exchange rates, price risk) only gained a high profile when the Basle Committee on Banking Supervision published "The Supervisory Treatment of Market Risks" in April 1993. This risk now requires increased attention and consideration due to the very volatile nature of interest and exchange rate movements. Interest rate volatility has increased dramatically over the past twenty-five years and for that an efficient management of this interest rate risk is strong required In this article, we will discuss about interest rate risk measurement as a main component of interest risk management. The article provides a overview of the various techniques used by banks to measure the exposure of earnings and of economic value to changes in interest rates. Their complexity ranges from simple calculations to static simulations using current holdings to highly sophisticated dynamic modelling techniques that reflect potential future business and business decisions. Also, the article presents an efficient practical example for measuring interest rate risk based on a methodology that is used with success by many Romanian banks and that is in accordance with Basel II Accord for Capital Requirements.