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FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks

A bank's treasury argues that interest rate risk in the banking book need not be included in economic capital because it is not part of the trading book VaR. What is the best response?

Banking book interest rate risk should be included, because mismatches in repricing can change economic value and earnings even when positions are held to maturity. Banks typically measure it as a distinct risk type within the economic capital framework.

  1. AAgree, since banking book positions are held to maturity and carry no value risk
  2. BDisagree, because banking book interest rate risk can affect economic value and earnings and is usually captured as a separate risk type in economic capitalCorrect
  3. CAgree, since credit risk capital already covers all rate movements
  4. DDisagree, but only if the bank is publicly listed

Explanation

Banking book interest rate exposures, such as repricing and basis mismatches, can change economic value and net interest income, so banks commonly measure them as their own risk type. Holding to maturity does not remove economic value risk, and credit capital does not cover rate moves.

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