Interest rate risk management by EME banks, BIS Quarterly Review, September 2023

The collapse of Silicon Valley Bank in March 2023 put a spotlight on banks' management of interest rate risk (IRR). Emerging market economies (EMEs) banks make less use of derivatives to manage IRR than their peers in many advanced economies. Instead, they mitigate IRR by extending floating rate or short-term loans with interest rate sensitivity similar to that of their deposits.

However, EME banks' exposure to interest rate-driven swings in valuation has been growing in recent years, as they have invested more in longer duration securities. This increases the importance of hedging the impact of interest rate changes on non-interest income.

As EME banks' balance sheets become more complex and business models change, hedging the impact of interest rate changes on non-interest sources of income and net worth might become more challenging. The increasing share of securities in EME banks' assets, the duration of banks' assets, and the expansion of fee income are all likely to increase the heft of IRR exposures that are inherently difficult to hedge by minimising repricing gaps.

Interest rate derivatives are a flexible tool for managing IRR, but these markets are still poorly developed in many EMEs. Removing obstacles to foreign participation in local derivatives markets can propel their development.

EME banks may need to make greater use of derivatives to hedge their IRR risk, but the development of these markets is still in its early stage.