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FRM Part I · FRM Exam Part I · Banks

A bank funds long-term fixed-rate loans with short-term deposits that reprice frequently. Which risk is most directly created, and what happens if short-term rates rise sharply?

This creates interest rate (repricing gap) risk. Short-term deposits reprice quickly while long-term fixed-rate loans do not, so a sharp rise in short-term rates raises funding costs faster than asset yields and reduces the bank's net interest income.

  1. AInterest rate risk; net interest income falls as funding costs rise faster than loan yieldsCorrect
  2. BCredit risk; loan defaults rise because deposits reprice
  3. CInterest rate risk; net interest income rises because deposits reprice upward
  4. DOperational risk; the bank cannot process the repricing

Explanation

The bank is liability-sensitive: liabilities reprice faster than assets. When rates rise, interest expense increases while fixed-rate loan income stays constant, squeezing net interest income. Option 3 reverses the effect.

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