TAILIEUCHUNG - STANDARDS OF SOUND BUSINESS PRACTICES - INTEREST RATE RISK MANAGEMENT

In the current crisis, the Keynesian response of stimulating aggregate demand through easy money and loose fiscal policy is correct to a point. But flooding the system with excess liquidity that drives short-term interest rates to near zero has been a serious mistake. By the end of 2008, the interest rates on federal funds and short-term Treasury Bills were virtually zero— where they remain today (figure 1). In this liquidity trap, the interbank market remains almost paralyzed so that further Fed injections of liquidity simply led to a buildup of excess reserves in . commercial banks without stimulating new lending. | STANDARDS OF SOUND BUSINESS PRACTICES INTEREST RATE RISK MANAGEMENT 2005 The Bank of Jamaica. All rights reserved Bank of Jamaica March 1996 Interest Rate Risk Management Page 2 INTEREST RATE RISK MANAGEMENT A. PURPOSE This documents sets out the minimum policies and procedures that each institution needs to have in place and apply within its interest rate risk management programme and the minimum criteria it should use to prudently manage and control its exposure to interest rate risk. Interest rate risk management must be conducted within the context of a comprehensive business plan. Although this document focuses on an institution s responsibility for managing interest rate risk it is not meant to imply that interest rate risk can be managed in isolation from other asset liability management considerations. B. DEFINITION Interest rate risk is the potential impact on an institution s earnings and net asset values of changes in interest rates. Interest rate risk arises when an institution s principal and interest cash flows including final maturities both on- and off-balance sheet have mismatched repricing dates. The amount at risk is a function of the magnitude and direction of interest rate changes and the size and maturity structure of the mismatch position. C. INTEREST RATE RISK MANAGEMENT PROGRAMME Managing interest rate risk is a fundamental component in the safe and sound management of all institutions. In involves prudently managing mismatch positions in order to control within set parameters the impact of changes in interest rates on the institution. Significant factors in managing the risk include the frequency volatility and direction of rate changes the slope of the interest rate yield curve the size of the interest-sensitive position and the basis for repricing at rollover dates. Although the particulars of interest rate risk management will differ among institutions depending upon the nature and complexity of their asset and liability structure both

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