Page 40 - Banking Fiannce March 2018

FEATURE

Understanding Interest Rate Risk at weighted average maturity of cash-flows of bonds in the
portfolio; and,
Banks
(c) The increase in yields denoted by ∆Y.
Let us start by first principles. Interest rate risk is most simply
understood by looking at the (approximate) price equation
For example, a portfolio of size 1 trillion with 10 years of
for a bond portfolio when there is a (small) change in the
duration, falls in value by 10 billion upon a 0.1% or 10 basis
underlying interest rates, such as the level of government’s points (bps) rise in the 10-year G-Sec benchmark yield.
borrowing cost:
∆P = – P X D X ∆Y, where
Let us consider each of these factors, in turn, in the present
∆ denotes change; P denotes the poftolio’s market value; and historical Indian context.
D denotes the “duration”, a neasure of the interest rate
sensitivity of the portfolio; Size of the Portfolio
and, Y denotes an underlying interest rate (or portfolio The share of commercial banks in outstanding G-Secs is
yield). around 40% (June 2017). Investment of Scheduled
Commercial Banks (SCBs) in G-Secs as a percentage of their
In other words, the value of the investment portfolio is a total investment was around 82% for FY 2016-17. The
function of three factors: corresponding figure for Public Sector Banks (PSBs) for FY
(a) The size of the portfolio denoted by P ; 2016-17 is slightly higher at 84%. This exposure has
(b) The duration denoted by D, which roughly captures the noticeably increased since 2014 (Chart 3a).

Chart 3a: Investment in Central Government securities as % of total investment

Chart 3b: Investment in Central Government securities as % of total assets

Source: Database on Indian Economy, RBI

40 | 2018 | MARCH | BANKING FINANCE