| Metric modelling | Description Risks captured Limitations | of metric |
| Net Interest Income-based: • Gap analysis: | Gap analysis allocates all relevant interest rate sensitive • instruments into predefined time buckets according to their contractually repricing fixed or maturity or based dates, which on behavioural are either • | The metric approximates the gap risk only linearly. It is based on the assumption |
| Repricing gap • Focus on net interest income (NII) component: Change of NII Unconditional cash flows (it is assumed that the timing of cash flows is independent of the specific Economic value: interest scenario) rate • Duration Modified analysis: | assumptions. It calc ulates the net positions (‘gaps’) in Gap risk (only parallel each time bucket. It approximates the change in net risk) interest rate income ensuing from a yield curve shift by multiplying each net position with the corresponding • interest rate change. The modified duration approximates the relative change in the net present value of a financial instrument due to a marginal parallel shift of the yield curve by one percentage point. The modified duration • of equity measures the exposure of an institution to gap risk in its non-trading book. PV01 of equity is derived from the modified duration of equity and measures the absolute basis point change (0.01%) of parallel the equity shift value of the resulting yield curve. from a 1 Gap risk) risk (only parallel | that all positions within a particular time bucket mature or reprice simultaneously. It fails to measure basis and option risk. The metric only applies to marginal shifts of the yield curve. In the presences of convexities, it may underestimate the effect of movements. larger interest rate |
| duration/PV01 of e quity | The starting point is the allocation of all cash flows of • interest rate sensitive instruments into time buckets. For each instrument type, an appropriate yield curve is • selected. The modified duration of each instrument is calculated from the change of its net present value due to a 1 percentage point parallel shift of the yield curve. The modified duration of equity is determined as the modified duration of assets times assets divided by | It only applies to parallel shifts of the yield curve. It fails to measure option risk and captures basis risk at best partially. |
| Cash flow Metric modelling | Description Risks captured Limitations equity minus the modified duration of liabilities times liabilities divided by equity. PV01 of equity is obtained by multiplying the modified duration of equity by the value of equity (i.e., assets minus liabilities) and dividing by 10 000 to arrive at the value change per basis point. The partial modified duration of an instrument for a specific time bucket is calculated as the modified • duration above, except that not the entire yield curve is shifted in parallel, but only the yield curve segment corresponding to the time bucket. These partial | of metric The metric only applies to marginal interest rate changes. In the presence of convexity, the |
| • Partial modified duration/partial PV01 | measures show the sensitivity of the market value of Gap risk (parallel and the banking book to a marginal shift of the yield curve non-parallel risk) in particular maturity segments. To each time bucket’s partial measure a different magnitude of a shift can be • applied, such that the effect of a change of the yield curve’s shape can be computed for the entire portfolio. | metric may underestimate the effect of larger interest rate movements. It fails to measure the basis and option risk. |
| Cash flows partially or fully conditional on interest rate scenario assumed the cash options, timing flows (it that of of of is Net based: Focus income Interest on net Income- interest (NII) | The change of NII is an earnings-based metric and measures the change of the net interest income over a particular time horizon (usually 1-5 years) resulting from a sudden or gradual interest rate movement. The interest buckets positions starting (or rate in using more point sensitive the sophisticated is exact the instruments mapping repricing systems). of to dates all (granular) cash of individual flows time of Gap non-parallel), and, flows risk provided are (parallel basis modelled all cash and risk • | Sensitivity modelling assumptions. of the and outcome behavioural to the |
| instruments with embedded, component: • Change of NII | The institution’s base scenario current for corporate the calculations plan to reflects pr oject the the scenario option risk dependent, also • | Complexity. |
| explicit options and – in more sophisticated approaches – of instruments of | volume, pricing and repricing dates of future business transactions. The interest rates used to calculate future cash flows in the base scenario are derived from forward rates, appropriate spreads or market expected rates for different instruments. | |
| Cash flow Metric modelling which the maturity depends on clients’ behaviour, is modelled conditional on the interest rate scenario) | Description Risks captured Limitations In assessing the possible extent of NII changes, banks use assumptions and models to predict the path of interest rates, the maturing of existing assets, liabilities and off-balance-sheet items, and their potential replacement. Net interest income-based metrics can be differentiated according to the sophistication of projecting future cash flows: simple run-off models assume that existing assets and liabilities mature without replacement; constant balance sheet models assume that maturing assets and liabilities are replaced by comparable instruments; while the most complex dynamic cash flow models reflect business responses to differing interest rate environments in the size and composition of the banking book. All earnings-based metrics can be used in a scenario or stochastic analysis. Earnings at risk (EaR) is an example of the latter, which measures the maximum NII change at a given confidence level. The change in EVE is the change in the net present value • of all cash flows originating from banking book assets, | of metric Sensitivity of the outcome to the modelling and behavioural |
| Economic Focus on value: economic | liabilities change positions in and run interest off. off-balance-sheet rates, assuming items that resulting all banking from book a Gap non-parallel), and, if risk all cash (parallel basis flows and risk are • | assumptions. Stochastic distributional fail to capture metrics, assumption, tail risks which and apply non- may |
| value of equity (EVE) • Change in EVE | The intere st rate risk can be assessed by the ∆EVE for modelled scenario specific ∆EVE using interest Monte rate scenarios Carlo or or historical by the distribution simulations. of dependent, risk also option • Economic value at risk (EVaR) is an example of the latter, which measures the maximum equity value change for a given confidence level. • | linearities. Full approaches revaluation are computationally Monte Carlo demanding and may be difficult to interpret (‘black - box’) . Complexity. |