Credit risk and interest rate risk management

Credit risk is probably the most significant type of risk for banks. This is due to the fact that regional banks in particular generate the majority of their net interest income by granting consumer loans and business loans. Because of this economic relevance, it is important for employees of credit institutions to understand the basic features of modern credit risk management and the respective modeling approaches which tend to look rather complex.

This module also covers the management of interest rate risks, which, along with credit risks, represent the most important risk class for credit institutions. They include unexpected, adverse effects of interest rate changes on the money and capital markets on a bank’s performance and/or economic value situation. This is due to maturity mismatches between the asset and liability sides (including derivatives), which already arise “naturally” from different maturity preferences of savers and borrowers and which the bank enters into in performing its economic function of maturity transformation. However, maturity transformation is not only a source of risk, but also an important component of net interest income for many banks. Thus, with a normal, steep yield curve, positive earnings contributions can be gained from the long-term provision of funds (e.g. loans) and short-term borrowing (e.g. savings deposits).

Step by step, we will explain the prerequisites for measuring credit risk at the individual borrower and portfolio levels as well as the basic methodologies for managing interest rate risk in credit institutions.