Page 37 - Banking Fiannce March 2018

FEATURE

UNDERSTANDING AND MANAGING

INTEREST RATE RISK AT BANKS

- Excerpts of Speech (c) Liquidity Coverage Ratio (LCR) regulation (under Basel-
III) also requires banks to hold High Quality Liquid Assets
In the period after the Global Financial Crisis, bank exposures (HQLA). Though there are other securities eligible as
to sovereign debt have increased significantly in many HQLA, the cost and ease of holding are the most
economies, including advanced ones, deepening the linkage attractive for sovereign bonds.
of bank balance sheets with sovereign debt. Several
important drivers are deemed to be at work behind this While sovereign bonds may be safer and more liquid than
phenomenon:
other instruments at a given point of time, there is no
(a) Exceptionally accommodative monetary policy in guarantee that they will remain so as both credit risk and
advanced economies, coupled with a general post-crisis liquidity risk of sovereign debt are dynamic in nature, and
fall in the risk appetite of global investors, created a
in fact, can shift deceptively so as these risks materialize
natural demand to hold sovereign debt of safe-haven
economies. from seemingly calm initial states.
(b) Under Basel capital regulations for banks, sovereign Sovereign debt-bank nexus and
bond exposures continue to attract 0% risk weight in
home countries and some currency unions, besides not Eurozone sovereign debt crisis
being subject to concentration limits. This makes The potential negative impact of sovereign debt-bank nexus
sovereign bonds a more attractive investment for banks and the need for addressing it has attracted much
vis-a-vis other assets of similar riskiness. Liquidity of international attention, particularly in Europe. Exposures of
sovereign bonds as well as such securities being eligible
resident banks to domestic sovereign debts in countries that
collateral for refinance by central banks only further
faced debt crisis (Greece, Italy, Ireland, Portugal, and Spain,
adds to their attractiveness.
or GIIPS) increased significantly during and after the crisis.
About the author Moreover, the increased exposure of banks to sovereign
debts exhibited a domestic bias in case of the riskier
Viral V Acharya sovereigns, i.e., the GIIPS, with share of resident banks
Deputy Governor increasing while that of non-residents declining; the holdings
Reserve Bank of India (RBI)
of resident banks continue to be at a high level (Chart 1).

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