Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition

Earnings-at-risk under ‘stress scenarios’

‘Those who cannot remember the past are condemned to repeat it.’ The management of a bank should be informed about the impact of a rare large change of interest rates on the net interest margin of the bank. For instance, in 2001, Turkey experienced short-term interest rates of 1000% when the liquidity dried up.

EAR_stress = |gap| × (big change of rates)

It is the task of the risk management team to imagine the very rare but possible large shocks that could impact the interest rates and affect the economy. Some banks have wisely created a ‘stress scenarios’ committee to select relevant stress scenarios. An analysis of the economic history of the country or of other countries provides examples of large ...