The Strategy Of Risk Management - 1541 Words

Banc One’s overall strategy of risk management is to stay within a permissible limit of earnings sensitivity. Based on the last meeting, it was decided that for 50 basis points increase (average over a year) in the interest rates, the level of earnings change should not be more than 4%. Banc One also used a balancing portfolio for asset-liability management, which consisted of investments in conventional securities and derivatives with an underlying mandate to achieve a reasonable rate of return, fulfill short term liquidity needs, manage interest rate exposure, and maintain a modest regulatory capital obligation. Also, Banc One has recently shifted its focus to synthetic instruments owing several advantages these new securities present. Specifically, Banc One aims to be liability sensitive i.e. have a negative earnings sensitivity. This means that the earnings are depressed in a period of interest rate increase. Having a controlled exposure to longer term fixed rate assets exceeding shorter term floating rate liabilities, the bank can earn the interest rate spread. This is because the yield curve is generally upward sloping, which implies that longer term securities will have a higher yield compared to shorter term securities. However, this leaves the bank exposed to interest rate risk when the yield curve has a large upward shift (the interest income falls more than the interest expense, and the earnings decline). 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