Managing Interest Rate Risk and its Impact on Banks

Interest rate risk in the banking book refers to the risk of a decline in a bank's earnings resulting from sharp movements in interest rates on its assets and liabilities. When interest rates rise, banks earn more on assets like loans and bonds, but they also pay more on liabilities like customer deposits. Mismatches in the timing of these interest rate changes can lead to reduced margins for banks. Housing loans and fixed rate mortgages can increase a bank's exposure to interest rate risk, while regulations and risk capital can affect the level of risk different banks face.