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| Measurement and Management of Interest Rate Risk in Commercial Banks: A Study Based on the Repricing Gap |
| LIU Chong, ZHANG Ziyan, LI Xinming, CHENG Zishuai
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School of Finance, Shanghai University of Finance and Economics;
Research Institute of Financial Innovation, Shanghai University of Finance and Economics & Shanghai Pudong Development Bank;
School of Finance, Nankai University |
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Abstract Interest rate risk (IRR) in commercial banks is widely recognized as a potential threat to financial stability. It can cause operating losses, erode banks' solvency, and weaken monetary policy transmission (Gomez et al., 2021). The Global Financial Stability Report notes that over one-quarter of countries and regions exhibit deficiencies in measuring and managing banks' interest rate risk. The failure of Silicon Valley Bank (SVB) underscored these concerns. According to the Federal Reserve's postmortem analysis, SVB altered key assumptions in its risk models, leading to an underestimation of interest rate risk and an inappropriate reduction of its derivative positions. This episode highlights two core elements of sound risk management in commercial banks: reliable risk metrics and prudent hedging strategies.
Accurate measurement forms the foundation of prudent IRR management. Repricing gap is the difference between interest-rate-sensitive assets and liabilities that are repriced within one year. It quantifies the sensitivity of a bank's net interest income to changes in market rates. Repricing gap is a commonly used, income-based indicator of IRR. Theoretically, the product of the one-year repricing gap and market rate changes predicts variations in net interest income.In practice, however, when the interest rates applied at the repricingof bank assets or liabilities do not adjust in line with movements in marketinterest rates, the repricing gap cannot accurately capture the response of netinterest income to market rate fluctuations. Thus, the effectiveness of this measure depends on how market-oriented the pricing of bank assets and liabilities is.
With China's ongoing interest rate liberalization reform, both the formation of market rates and banks' pricing behavior have undergone major transformations. Pricing benchmarks for assets and liabilities have shifted from administratively regulated rates to market-determined ones. Historically, benchmark deposit and lending rates served as key monetary policy instruments. As interest rate liberalization reform deepened, the floating ranges around these benchmarks widened. The ceiling on lending rates and floor on deposit rates were removed in 2004, and controls on lending (deposit) rates were fully lifted in 2013 (2015). During this transition, the People's Bank of China (PBOC) moved from direct rate controls to a market-based framework, using monetary policy tools to guide market rates indirectly. Since October 2015, benchmark deposit and lending rates have remained unchanged and effectively phased out.
Currently, deposit rates are largely set by financial institutions, subject to industry self-discipline mechanisms that cap rates to ensure fair competition. Lending rates are independently determined and anchored to the Loan Prime Rate (LPR), now the principal benchmark for loan pricing. These shifts in pricing mechanisms of banks have increased the sensitivity of their interest income and expenses to market rate fluctuations. Theoretically, this should enhance the repricing gap's effectiveness as a measure of IRR. Hence, examining how the repricing gap performs across different stages of the reform helps test its theoretical validity and provides empirical evidence to improve risk models and hedging strategies for financial institutions.
China is currently in the deepening stage of interest rate liberalization reform, yet empirical evidence on the effectiveness of the repricing gap and the hedging performance of interest rate derivatives remains limited. Using annual reports of China's commercial banks from 2010 to 2020, this study conducts a comprehensive empirical analysis and yields three main findings. First, the average repricing gap during the sample period is negative and trending downward, indicating that liabilities reprice faster than assets. This asymmetry helps ease the pressure of narrowing net interest margins when market rates decline. Second, the link between the repricing gap and the sensitivity of net interest margins to market rates becomes significant only after 2015, when benchmark rates ceased to be adjusted. This suggests that the gap's effectiveness in capturing interest rate risk has strengthened with the reform. Third, banks' usage of interest rate derivatives reduces the sensitivity of net interest margins to market rate fluctuations, confirming their value in managing interest rate risk. These findings offer empirical insights for optimizing banks' risk management frameworks and establishing a long-term mechanism for financial stability.
The paper's marginal contributions are threefold. First, it extends the literature on identifying and measuring IRR in commercial banks. Focusing on the core issue of indicator effectiveness, it goes beyond prior domestic studies that mainly compare measurement methods qualitatively by providing empirical evidence on their sensitivity, precision, and applicability. Second, within the context of China's interest rate liberalization reform, the paper demonstrates empirically that the effectiveness of the repricing gap depends on the mechanism of interest rate formation. From a micro-level perspective, it explains how the marketization of rates improves measurement accuracy, enriching empirical research on IRR. Third, conditional on effective risk measurement, it evaluates the actual hedging performance of interest rate derivatives, verifying their role in mitigating banks' exposure to interest rate fluctuations and contributing to the literature on derivative-based risk management.
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Received: 14 April 2025
Published: 01 February 2026
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