Study on the Financial Management of Prime Bank Limited: Part 05

In this final part of the "Financial Management of Prime Bank Limited" blog series (Part 01, Part 02, Part 03, and Part 04), interest rate risk management and market risk management are discussed.

Interest Rate Risk Management of PBL

To understand the interest rate risk management of Prime Bank Limited Repricing/Funding Gap Model is used. Table 21 shows the repricing gaps for 2010-14 in 6 categories. Here, it can be observed that the bank has a cumulative negative repricing gap over the years representing more rate sensitive liabilities than rate sensitive assets. It interprets that rising interest rate would have negative effect on the bank’s earnings because the bank will have to source fund with higher interest rate while their earlier assets were utilized at lower interest rate. In addition, rising borrowing rate will lead the rise in lending rate which is a negative incentive to borrowing, therefore, the bank may need to economize their spread. Reverse scenario can be observed in case of decrease of interest rate.

Table 21: Repricing Gaps (in million Tk)

In Bangladesh, as interest rate showed a decreasing trend over the last couple of years as evident by declining yield curve of government securities, the maintenance of negative gap seems logical for Prime Bank. As they are having negative gaps, their liabilities are repricing early on lower interest rate than the assets. The effects of interest rate decrease on net interest income can be shown with the following formula.

 

Where, ∆NII	= Change in net interest income in the ith bracket;
GAPi	= The taka gap between the book value of assets and liabilities in maturity bracket i
∆Ri	= The change in the level of interest rates impacting assets and liabilities in the ith bracket

By applying this formula for cumulative gap it is found that for 1% decrease of interest rate the NII of PBL would have increased by  Tk. 85.17 million (2010), Tk. 209.67 million (2011), Tk. 211.63 million (2012), Tk. 483.18 million (2013), and Tk. 574.71 million (2014). Contrary, the increase of interest rate would have the reverse effect of NII.

Market Risk Management of PBL

Market risk is calculated by Daily Earnings at Risk (DEAR) and Value at Risk (VAR).

DEAR for Equity Portfolio

Table 22 shows the DEAR for equity portfolio of PBL for 2011-14. The value of Equity position is the market value of quoted share held as investment. As unquoted shares’ values do not change with market, these are not considered here. PBL did not have any quoted share in 2010, so DEAR is not calculated for 2010. The Standard Deviation of market Return is calculated from daily return of DSEX index in 2014 and used as a proxy for every year. It can be seen that the potential daily loss on position increases as the value of position increases. For PBL, the maximum equity position is observed in 2013 of Tk. 256.34 and the potential loss exposure for that year is also the highest at Tk. 2.28 million. On the other hand, the lowest exposure of Tk. 0.52 million is seen in 2011 because of minimum equity position of Tk. 58.40 million.

Table 22: DEAR for Equity Portfolio
	Particulars		2011	2012	2013	2014
1	Equity Position (million Tk)		58.40	250.51	256.34	238.27
2	Standard Deviation of market Return (m)		0.007412
3	Beta (B)		1.2
4	Stock Market Return Volatility	2*3	0.008895
5	DEAR (million Tk)	1*4	0.52	2.23	2.28	2.12

DEAR for Loan Portfolio

Table 23 shows the DEAR for loan portfolio of PBL. It can be observed that the potential daily loss on the position was the maximum in December 31, 2012 which was about Tk. 1,893.44 million if the one bad day in 2000 (5bps or .05% chance, therefore, 100/0.05) would have occurred in January 01, 2013. The lowest potential loss was seen in 2010 of about Tk. 1438.65 million.

Table 23: DEAR for Loan Portfolio

DEAR for Total Portfolio

Table 24 shows the DEAR for total portfolio of PBL. It can be seen that the potential risk of total portfolio position of PBL was the highest in 2012 (Tk. 1893.89 million) and the lowest amount (Tk. 1438.65 million) was observed in 2010. Here, by considering the risk of each position and the correlation structure among those position’s returns, portfolio DEAR is found and this value is lower than the sum of DEAR of individual position because some degree of one’s risk is offsetting by others.

Table 24: DEAR for Total Portfolio (in million Taka)
	2010	2011	2012	2013	2014
DEAR for Equity Portfolio	0.00	0.52	2.23	2.28	2.12
DEAR for Loan Portfolio	1438.65	1585.13	1893.44	1853.72	1711.30
Correlation	0.20
DEAR for Total Portfolio	1438.65	1585.23	1893.89	1854.18	1711.72

VAR for Loan Portfolio

From table 25 it is found that, for loan portfolio, the Market Value at Risk (VAR) of PBL was the highest in 2012 for 30 days, about Tk. 10,370.82 million and the minimum potential loss for 30 days was in 2010 which was Tk. 7879.81 million.

Table 25: VAR for Loan Portfolio (in million Taka)
	2010	2011	2012	2013	2014
DEAR for Loan Portfolio	1438.65	1585.13	1893.44	1853.72	1711.30
N (days)	30
VAR (= DEAR x N^0.5)	7879.81	8682.10	10370.82	10153.26	9373.16