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FRM Part I · FRM Exam Part I · Banks

A bank has a large book of long-term fixed-rate loans funded mainly by short-term deposits that reprice frequently. Which risk is this structure most directly exposed to, and what move in rates hurts it?

The bank faces interest rate risk from a maturity mismatch. Its funding reprices quickly while its loans earn fixed rates, so a rise in short-term rates raises funding costs without raising loan income, compressing net interest margin. A rate fall would benefit it.

  1. ACredit risk; a fall in borrower credit quality
  2. BInterest rate risk; a rise in short-term rates compressing net interest marginCorrect
  3. CInterest rate risk; a fall in short-term rates compressing net interest margin
  4. DLiquidity risk only; a rise in long-term rates increasing deposit outflows

Explanation

Liabilities reprice faster than assets, so the bank is liability-sensitive. When short-term rates rise, funding costs increase while loan income stays fixed, squeezing net interest margin. A fall in rates would help the bank.

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