Gap Management in Commercial Banks : An Analysis of Commercial Banks' Exposure to Interest Rate Risk

Fluctuations of interest rates have huge effects on commercial banks’ performance. The main purpose of this thesis is to comparatively study the theories and strategies surrounding the management of interest rate risk for commercial banks. There are mainly two types of methods for measuring interest rate risk, which are, interest rate gap and duration gap. The mechanics of interest rates are also covered for the purpose of gaining a theoretical platform for the interest rate risk management theories. Managing interest rate risk can be implemented through rebalancing the bank’s asset-liability portfolio and also through hedging with interest rate futures, options and swaps which has become more widely used among banks during the last few years. A couple of descriptive cases are undertaken in order to get a deeper understanding about the impacts of interest rate movements on commercial banks’ earnings. In addition, the Swedish commercial bank Ikanobanken’s exposure to interest rate risk during the first six months of year 2003 is analyzed in this thesis and we find that Ikanobanken’s position was wrong during this period and as a result losses were incurred due to their interest rate exposure.