Study of interest rate risk of Indian banks

Abstract

_ India has a long history of public and private banking. Modern Banking in India began in the 18th century and has transformed itself to play an integral part in the Indian Economy._ With banks playing such an integral role with the economy, they are also exposed to various risks that the economy faces in the global context and the banks are liable to manage such risks with utmost tenacity._ For a long time, Indian Banks have been focusing on core banking products and most of their income comprises of Interest Income thus exposing to varying degrees of interest Rate Risk._ This project measures the exposure of a select set of Indian Banks to Interest Rate Risk using two methodologies sensitivity of Stock returns of the Banks to the variation in the Stock Index and the Bond Index (Stone s two-factor model) and the determination of exposure using variation in Net Interest Margin and Spread of the Bank (DuPont analysis)_ Stone s two factor model method comprises of running the regressions for the excess(against the 1-month MIBOR) monthly stock returns of the sample set of banks against the excess stock and bond index returns and arriving at a Risk Index value for each of the chosen banks._ From the Risk Index values arrived using Stone s model and the three risk buckets arrived at, it can be concluded that most of the Indian Banks face medium to high exposure to interest rate risk._ The second model, which uses the variation in the ratios from DuPont analysis over the sample period of time, indicates that only a small number of banks in India have limited exposure to interest rate risk.