Interrest rate risk management a case study of saigon commercial bank

To manage interest rate risk, many measurement techniques have been used such as dollar gap, duration gap, simulation analysis, value at risk analysis, and option adjusted spread analysi

TRẦN THIỆN DUY

MASTER’S THESIS

In Finance- Banking Ology Code: 60.31.12

Supervisor

Ph.D NGUYỄN THỊ NGỌC TRANG

Ho Chi Minh City -2010

Acknowledgements

I would like to express my heartfelt gratitude and deepest appreciation to my research supervisor, Ph.D Nguyen Thi Ngoc Trang for her precious guidance, share of experience, ceaseless encouragement and valuable suggestion, advice and help Without her, this study could not have been completed

Special thanks are sent to all instructors and staff at Postgraduate Faculty, University of Economics Ho Chi Minh city (UEH) for their support and valuable knowledge during my study in UEH I also express my appreciation to Professor Dr Nguyen Dong Phong, UEH deputy rector, for creating the MBA program in English

I also wish to thank my colleagues from SCB, my friends in Tinnghia bank, Vietbank, ACB, Saigonbank, LienViet bank, HDbank

to help me during colleting data as well as support me during doing research Specially, my thanks go to Mrs Hua Minh Dai University of Phoenix in Arizona USA, and Mr Nguyen Huu Thu- banking specialist- for a lot of useful information and advice sent during my study

Last but not least, the deepest and most sincere gratitude goes to

my beloved mother, elder brother and my wife Nguyen Vu Phuong Giao for their boundless support and encouragement during my entire study period

Abstract

Interest rate risk is one of important financial risks to banking business as other financial intermediaries The fluctuation of interest rate risk affects directly the bank’s balance sheet issuances The changed structure of bank’s balance sheet causes the relative movement

of a bank’s earnings and net worth

Many large banks have to set up their own process and principles

to manage interest rate risk which is based on the content guidelines of Basel II as the standard procedure in terms of risk management in order

to manage interest rate risk

To manage interest rate risk, many measurement techniques have been used such as dollar gap, duration gap, simulation analysis, value at risk analysis, and option adjusted spread analysis Each method has its strengths and weaknesses Choosing an appropriate method depends on the source of interest rate risk, the complexity of operation and capability of that model While some foreign banks in Vietnam such as HSBC, ANZ use simulation and value at risk as main techniques for interest rate risk measurement, a large number of Vietnamese banks measure their interest rate risk by the maturity gap or dollar gap method

as fundamental analysis Actually, some banks in Vietnam do not pay attention to interest rate measurement seriously Therefore, this paper emphasizes current methods that Vietnamese banks have been using to measure interest rate risk, and analyzes the advantages and disadvantages of those methods In reality, the current method that Vietnamese banks use to calculate their interest rate risk is inappropriate due to the interest rate fluctuation in recent years and it

shall need being replaced A more appropriate method, earning simulation model or income simulation model, which can cover all shortcomings of the dollar gap should be discussed and suggested to apply for interest rate risk measurement in the context of Vietnam

Basing on the analysis of real situations, this paper also proposes some recommendations for the Vietnamese banking system to apply such a model in real condition and as well for the government in macroeconomic management

Keywords: dollar gap; duration gap; income simulation model; interest rate risk; spread

Table of contents

Acknowledgements i

Abstract ii

Table of contents iv

List of figures vi

Abbreviations vii

Chapter 1: Introduction 1.1 Rationale 1

1.2 Problem statement 3

1.3 Research questions 6

1.4 Research objectives 6

1.5 Significance 6

1.6 Research methodology 7

1.7 Structure of research 8

Chapter 2: Literature review 2.1 Asset/Liability Management 9

2.2 Interest rate risk 10

2.3 Interest rate risk structure 10

2.4 Interest rate risk measurement 11

2.5 Conclusion 20

Chapter 3: Methodology 3.1 Research design 21

3.2 Data collection 22

3.2.1 Document collection 23

3.2.2 Personal interview 23

3.3 Data analysis 25

3.4 Conclusion 25

Chapter 4: Analysis and findings 4.1 Introduction 26

4.2 The findings of data analysis 27

4.2.1 Measure interest rate risk in Vietnamese banks 27

4.2.2 Advantages and disadvantages of current methods 38

4.2.2.1 The advantages of current methods 38

4.2.2.2 The disadvantages of current methods 39

4.2.3 Experience of measuring interest rate risk .40

4.2.4 Expectation of interest rate risk measurement 42

4.2.5 Measuring interest rate risk with income simulation model 43

4.2.6 Conclusion 47

Chapter 5: Conclusion 5.1 Conclusions to research questions .49

5.2 Recommendations 51

5.2.1 Recommendations for Vietnamese banks 51

5.2.2 Recommendations for the government 53

5.3 Limitations of research 54

References 55

Appendixes 58

List of figures

Figure 4.1 : Sample of gap report

Figure 4.2 : Sample graphic displays

Figure 4.3 : IRR measurement (for example 1% increase)

Figure 4.4 : Adjusted interest rate risk measurement

Figure 4.5 : Average mobilizing rate and lending rate 2008-2010 Figure 4.6 : Framework of income simulation model

Abbreviations

ALCO : Asset and Liability Management Committee ALM : Asset and Liability Management

CDs : Certificate of deposits CIC : Credit information centre GSO : General statistic office IRR : Interest rate risk

RSA : Interest rate sensitive asset RSL : Interest rate sensitive liability SBV : State Bank of Vietnam

VND : Vietnam dong WTO : World trade organization

Chapter 1: Introduction 1.1 Rationale

At the end of 2007, Vietnam was confronted with the economy overheating resulting from massive capital inflows The government had to push out VND to absorb approximately 10 billion US dollar and increased monetary base in the economy resulting in double-digit inflation appearance At the same time, global financial crisis has been occurred The financial crisis, originating in the United States, affected foreign demand and global financial market The international prices of commodities exported by Vietnam were on a declining trend, export orders for garments and other industrial products collapsed, and a slowdown in manufacturing became noticeable The government reacted swiftly to economic shock Subsequent stimulus measures have prevented a collapse of economic activity and have put the economy on

a recovery track Vietnam had to raise massive of financial and monetary polices to rebalance the economy The government has applied a tightened monetary policy which demonstrated the government‘s resolution in maintaining the priority policy on inflation control and growth Some of those were issuance of central bank note, increasing reserve requirement ratio and interest rate hikes to withdraw money out off economy SBV applied strict tightened monetary policies through the prime rate adjustment They increased prime rate

up to 12% in June 2008 and reached to 14% in July 2008, lasting until December of 2008 In the last quarter of 2008, when the inflation was

in controllable situation, SBV changed their monetary policies in order

to accelerate for growth objective ahead The government opened their

monetary supply basing on observation, control, and flexible reactions

to unforeseen outside impact The State Bank of Vietnam greatly relaxed monetary policy from November 2009 onwards, confirming a trend cautiously initiated in June They have implemented to bring down the prime rate to 7% since the first quarter of 2009 and cut down the required reserve ratio Since that time, the government has continuously followed flexible policies in order to stabilize economy

The subsequences of financial crisis and substantial adjustment

of government policies have pushed commercial banks in Vietnam into interest rate race which been lasted competitively After SBV deregulated ceiling deposit interest rate of 12% and boost basic interest rate up by 12%, actually up by 14%, lending interest rate had been up

by 18% as well Most of banks had increased mobilizing interest rate to attract capital and borrowed from inter-bank market to meet liquidity requirement for solving their difficulty situation During to the crisis period, inter-bank market rate had reached to peak of 20% and lending interest rate had increased up by 21% Most of commercial banks had fallen into difficult situation of facing interest rate risk when interest rate has been moving in large spread and uncontrollable They had to adjust their profit plan and increase their capital adequacy for meeting the safety requirement

Various later analyses showed that one of reasons leading to heavily impacts of financial crisis to Vietnamese banks is that a number

of Vietnamese banks have ignored risk management assignments, especially in interest rate risk management which directly effects to interest income of banks Because they have been lack of interest rate risk monitoring, measuring and controlling methods and business

contingency plan as well, so they have been bearing interest rate passively

Therefore, a measurement of interest rate risk should be learned and applied in order to limit the interest rate risk impacting to the interest income in the condition of interest rate fluctuation, unpredictable financial market problems and government policies for oriented- market economy

In order to meet the regulation of Basel II, principles for the management and supervision of interest rate risk, 2004, Vietnamese banks should not only establish rate management process including business strategy, system of internal controls but also incorporate the supervisory treatment of interest rate risk in the banking book In particular, Vietnamese banks should have got “effective interest rate risk measurement, monitoring and controlling function within the interest rate risk management process”

1.2 Problem statement

Vietnam has to open financial market in the rout of entering WTO, so the requirement of risk management in the banking sector becomes more necessary for integrating global financial business and competing with foreign banks The application of risk management standard is not only essential for asset and liability management but also helpful for raising capability of banking management

The interest rate risk management is properly a part of asset and liability management An important purpose of asset and liability management is that how to adjust the items on balance sheet and off-balance sheet in order to mitigate the effect of changing interest rate to

projected profit Therefore, the problem is that how to measure the interest rate risk for mitigating the impact of interest rate to interest income

According to interest rate risk measurement of a number of banks in Vietnam, the interest rate risk has been measured by gap analysis The dollar-value gap analysis, the simple form measurement,

is the dollar value of those assets on a bank's balance sheet that are sensitive to changes in interest rates, less the bank's liabilities that are sensitive to interest rate changes in specific time band The gap between sensitive assets and sensitive liability reflect bank sensitivity position The changes in net interest income can be calculated by multiply dollar volume gap with the changing of interest rate However,

it is simple and do not meet the need of the interest rate risk management

To recover the weaknesses of the dollar gap analysis, duration gap analysis, a more sophisticated form of interest rate risk measurement, can be applied The duration gap is a measure of an asset’s or a liability's sensitivity to a given change in interest rates A bank's duration gap is the dollar-weighted duration of the bank's assets less the dollar-weighted duration of the bank's liabilities Banks with a positive duration gap see net interest margins widen if interest rates were to rise (or to see net interest margin erode if rates were to fall) Banks with a negative gap would see net interest margin erode if rates rise (or would see net interest margin widen if rates were to fall) The duration gap is not only useful tool for measuring how net worth of a bank will change if interest rate move up or down by 100 basic points, but it also serves for hedging risk with derivatives Basing on the

duration method, banks can manage and forecast the interest rate risk that effects to their equity and capital However, like the dollar gap, the duration gap is also a statistic approach which maybe inflexible when some factors in that model change

An approach which should be studied and applied is simulation model that is more dynamic and retrieve all weaknesses of dollar gap and duration gap Some large banks in the world use it as virtual advanced method for measuring interest rate risk basing on historical data and powerful analysis of computer Simulation is a complicated method and can forecast rather exactly what arise in future for each economic scenario Simulation analysis utilizes computers to measure IRR and the impact of different funding or business strategies under numerous interest rate scenarios Simulation analysis combines an institution’s current financial position with expected future events to quantify the impact that changing interest rates would have on projected earnings and market value of equity

There are two types of simulation analysis that may be carried out to evaluate IRR: income simulation and market value of equity simulation Because income simulation is useful, forward-looking analysis and a considerable enhancement over the "static" analysis of gap and duration techniques, it is suggested as main method in Vietnamese banks which is used to forecast how net interest income, as well as net income, changes in response to changes in interest rates

Therefore, this study analyzes the weaknesses of recent interest rate risk calculation as scientific bases to suggest income simulation to measure interest rate risk and assesses institutions interest position for

managing interest rate risks Relying on that analysis, the banker can make their decision about trading securities, investment or lending activities every day effectively

1.3 Research questions

The research problems defined above lead to following research questions:

How do Vietnamese banks measure interest rate risk?

What are the advantages and disadvantages of current interest rate risk methods?

How is interest rate risk measured by income simulation model in context of Vietnam?

1.4 Research objectives

In solving research problems, this study has research objectives:

To identify appropriate method for measuring interest rate risk

To contribute some knowledge to interest rate risk management

1.5 Significance

Vietnamese banks can use income simulation as principal measurement to manage asset and liability on balance sheet and off-balance sheet to ensure that their interest income moving in guideline

Income simulation can be learn as an appropriate measurement which the bank need to deal with under Pillar 2 of Basel II, particularly represented in Principles 12 to 15

1.6 Research Methodology

Zikmund (1997) discusses three types of business research: exploratory, descriptive and causal research Exploratory research is conducted to clarify and define the nature of problem Descriptive research is designed to describe the characteristics of population or phenomenon Causal research is conducted to identify cause-and-effect relationship among variables where the research problem has been narrowly defined

Choosing a type of research depends upon research questions that research wants to answer This research study is to analyze what Vietnamese banks do to measure interest rate risk, evaluates the performance of recent methods and apply earning simulation model into interest rate risk calculation Therefore, “Exploratory” is the appropriate type of research

Selecting research design is the next step after choosing type of research There are four types of research design: survey; experiments; observation and secondary data Zikmund (1997) Basing on the advantage and disadvantage of each research design, survey method is used in this research

Survey was chosen in this research to investigate the performance of Vietnamese banks in terms of interest rate measurement and identify the advantage and disadvantage of recent method A questionnaire was designed and directly asked to interviewees to collect data related to the performance of their bank in terms of interest rate risk calculation, how they do to measure interest rate risk and the

information form the survey maybe more appropriate in case lack of secondary data

For the purpose of illustrating clearly viewpoint of researcher, secondary data such as financial statement, interest rate and relative items available from website or collecting directly from Vietnamese banks was used in this study

1.7 Structure of research

This study consists of five chapters Chapter 1 introduces the research including the rationale of study, the problem of research, research questions, research objectives and significance of study The second chapter overviews some theories of interest risk management Chapter 3 reviews the methodology of research Chapter 4 analyses data and presents the findings of research The last Chapter points out the conclusions of research and recommendations

Chapter 2: Literature review 2.1 Asset/Liability Management

Asset liability management is a common name for the complete set of techniques used to manage risk within a general enterprise risk management framework Asset/Liability Management is defined as the set of technique to control value creation and risks in a bank, J Demine (2002)

As define of Asset/Liabilities Management, Beton E.Gup (2005), chapter 5, the process of making daily decision such as making loan, buying and selling securities, investing or lending activities about composition of asset and liabilities and the risk management is know as Asset/Liabilities Management Risk management is also a part of ALM Hence, the purpose of ALM is partially to control the size of bank’ net interest income and also to consider the affects of the change on the value of balance sheet items

Peter Rose (1999) expressed that Asset and liability management

is the financial risk management of any financial institution The liability management formulates strategies and takes actions that maximize the risk adjusted returns to shareholders over the long run Following the viewpoint of Peter Rose (1999) in his book Asset and Liabilities Management, the principal goals of asset and liability management are to maximize, or at least stabilize, the bank’s margin,

asset-or spread between interest revenues and interest expenses, and to maximize, or at least protect, the value (stock price) of the bank, at an acceptable level of risk

2.2 Interest rate risk

As defined in Basel II (2004), “interest rate risk is the exposure

of a bank’s financial condition to adverse movements in interest rate.”

A bank can accept interest rate risk as a normal part of banking activity However, excessive interest rate risk can affect significantly to earning and capital base

Interest rate risk is also a concern of Asset and liability management When interest rates change, the changes affect banks’ interest income of loans and securities, and interest cost of deposits and other bank borrowings A fluctuation of interest rates also changes the market value of a bank’s assets and liabilities, thereby changing the bank’s net worth (that is the value of the owners’ investment in the bank) Thus, the changes of interest rate affect both a bank’s balance sheet and its statement of income and expenses

2.3 Interest rate risk structure

As defined in the Basel paper, July 2004, the four types of structural interest rate risk are repricing (mismatch), yield curve, basis risk and optionality

Repricing or mismatch risk is created when fixed rate loans are funded by variable rate borrowings or when fixed rate deposits fund variable rate loans This type of risk generates the largest amount of earnings variations

Yield curve risk is the result of fixed rate loans being funded by fixed rate deposits of a different term Yield curve risk usually does not affect earnings variation because the terms are beyond the 12-

month earnings period Yield curve risk requires an equity-at-risk measure

Basis risk arises when variable rate loans are funded by variable rate deposits that change rates at different speeds When variable rates move at different speeds, earnings variation rises

Finally, optionality risk is formed from options embedded in many products Optionality risk changes the maturity or the payment profile of products As such, optionality can impact both the earnings and equity measures

2.4 Interest rate risk Measurement

A question is raised that how to measure interest rate in risk management An effective risk management process is that how to measure interest rate risk, control interest rate risk within prudent levels

in order to keep banking on safety and soundness

To manage interest rate risk, banks have to measure how much it affects bank income and net worth As concern on The Management of Risk, Beton E.Gup, Chapter 5, there are three technique of dealing with interest rate risk They are dollar gap, duration gap and simulation

The traditional measure of interest rate risk is the dollar gap (referred to as the funding gap or the maturity gap) between assets and liabilities which based on the repricing interval of each component of balance sheet It is the earliest way and easiest to understand

To compute dollar gap, assets and liabilities would be grouped into interest rate sensitive or non interest rate sensitive Interest rate sensitive assets are those that reprice within some defined period and

interest rate sensitive liabilities are those that reprice in the same period With each category, the gap is expressed as dollar amount minus liabilities

So dollar gap is the different between the dollar amount of interest rate sensitive assets (RSA) and the dollar amount of interest rate sensitive liabilities (RSL)

Gap($)= RSA($)-RSL($) The gap can have a positive value or negative value A bank would have a positive gap if its RSA were higher than RSL that is call asset sensitive In contrary, that bank is liabilities sensitive

If bank is sensitive asset, their interest income will increase when interest rate increases and vice versa

The effects of changing interest rate on net interest income for banks with different position can be calculation as followed formula:

NII= RSA
I – RSL
I= Gap
I Where:

NII is the expected change in the dollar amount of net interest income

I is the expected change in interest rate in percentage points The maturity gap suggests how a bank responds to a given change in interest rate For example, smaller banks and thrifts have had longer average maturity on the asset side than the liability side They often use short-term deposits to fund long-term assets such as fix-rate mortgage–loan They would have a large negative maturity gap in short-term brackets and large positive maturity gap in long-term

brackets, meaning that short-term liability exceed short-term assets and long –term assets exceed long-term liability In this situation, a rise in interest rate would lead to a higher cost of fund before loan rate could adjust and lowering their profits

However, this approach omits some factors including cash flow, unequal interest rate on asset and liability and initial net worth

Peter Rose (1999), Chapter 6, also concerned some problems with dollar gap management Firstly, interest rates paid on liabilities tend to move faster than interest rates earned on assets Secondly, interest rate attached to bank assets and liabilities do not move at the same speed as market interest rates Thirdly, point at which some assets and liabilities are repriced is not easy to identify At last, interest-sensitive gap does not consider impact of changing interest rates on equity position

Advantage theory for this problem is duration concept This concept, first introduced by Ferderick R Macaulay in the pricing of the interest sensitivity of bond, considers the timing of cash flows both before and at present asset and liability maturities Duration is defined

as present –value weighted time to maturity

Macaulay duration was formulated in 1938 Macaulay duration involves three simple calculations:

Determine the time remaining until the payment of receipt of each cash flow from an instrument is determined

Weight those time periods by multiplying each by the ratio of the present value of that cash flow to the instrument's total present value

Calculate the sum of the weighted time periods

xt TPV

CF PV

n t

t

∑=

durationMacaulay

Modified Duration gives an estimate of price volatility

t = the number of periods remaining until the receipt of cash flow CFt = the cash flow received in period t

PV = the present value function 1/(1+r)tTPV = total present value of all future cash flows

n = the number of periods remaining until maturity However, the Macaulay duration is accurate only if the yield curve is flat and the shifts in the yield curve are parallel

Duration gap is based on Macaulay’s concept duration The excellence introduction about duration theory are provided by George G.Kaufman (1985), and French (1988), and on more academic plane, Grove (1974) Gerald O Bierwag (1987) also researched in detail about duration gap in his book Duration analysis: Managing interest rate Risk Beirwag and G.Kaufman (1985) attempt to clarify duration for financial institutions by providing several single-factor duration gap equation because different duration gap equation should be adopted for

i) (1

Duration s

Macaulay' Duration

Modified

+

=

i Duration Modified

P

alternative “target” account which would be immunized by the institution

Shaffer (1991) also concerned over the restrictive condition of flat yield curve in using Macaulay’s duration and added that change in interest rate must be small for immunization to be effective He concluded that the restrictive conditions were one reason why many financial institutions had been hesitant to adopt duration gap as means

of controlling interest rate risk

Cherin and Hanson (1997) examined the immunization strategy

of matching the duration of a fixed income portfolio with investment horizon They pointed out that most illustration had been concentrated

on the duration of principal payments but ignored the duration of accumulated interest payments More specifically, these illustrations presented a change in principal value when interest rates change, but did not show a similar change in the value of accumulated interest So they suggested that a more compatible treatment would be assume both principal and accumulated interest are in bonds that are duration matched to the investment horizon, thus resulting in an increasing in the value of both principal and accumulated interest when interest rate declines

Kristin L Beck, Elizabeth F Goldreyer and Louis J D’Antonio (2000) demonstrate that the yield and duration of a portfolio of fixed income instrument are not necessarily equal to the weighted average of the yields and duration of each individual asset The yield and duration

of bank’s portfolio of fixed income would be determined by portfolio’

cash flow In addition, they directly integrated both fund management and capital adequacy with portfolio

Beton E Gup and James W Kolari 3th,(2005) also introduced his theory in commercial banking Duration is defined as the weighted average time to received all cash flows from a financial instrument The duration gap is the difference between the duration of assets and liabilities It is a measure of interest rate sensitivity to show how interest rate affect the market value of bank assets and liabilities and its net worth or equity The net worth is the difference between assets and liabilities Therefore, the changing in market value of assets and liabilities will change the value of net worth or equity

By using duration, net worth of bank can be calculated as formula

NW=
A –
L Market Value of equity should be the gap between the present value of assets and the present value of liabilities

NW MV = A PV – L PV

A PV : present value of assets

L PV : the present value of liabilities

As mentioning above, To calculate the duration of asset

Calculation the duration of liabilities

A i

L i

D

Duration gap is computed

The technique was devised to determine what percentage change

in present value would result from one percentage or 100 basis points change in interest rate

The key element distinguishing between maturity gap from duration is cash flow in terms of both its timing and its amounts However, it is not easily done in duration gap analysis It is not accurately for bank estimate cash flow because it is uncertain

In simply form, duration provides correct answer to formulate change in value only under special conditions The most restrictive

A

L

*D-DDgap= A L

i

* D - - A

* i) (1

i

* D -

A

* i) (1

i

* DGAP -

i

*DGAP-

∆

=

conditions are that the movements of interest rate are small and term interest rate equals short-term interest rate in all any time

long-In addition, another assumption, in both dollar gap and duration gap analysis that we have used, is that when interest rate changes, the interest rate of all maturities changes by exactly the same amount, Chapter 9 - Frederic S.Mishkin It means that the slope of yield cure remain unchanged

Simulation model is used popularly by many large banks With model computer system, they can use this model to measure interest rate risk more accurately

As research of James V.Houpt and James A.Embersit, Federal Reserve Bulletin, 1991, they supposed some method of measurement interest rate risk in US commercial banks They combined both risk measure which are duration of net worth and sensitivity index to evaluate a bank’s interest rate In 1996, James V.Houpt and James A.Embersit discussed about the basic screening model, the basic model, which used “Call Report data” to estimate the interest rate risk of banks

in terms of economic value

J Dermine and Y F Bissada, 2002, expressed simulation theory that recover the weakness of two theory dollar gap and duration gap In this theory, assumption of parallel movement of interest rate is not always valid In practice, they seldom move in the same way Simulation can be more perfect than other model in this respect

Beton E Gup and James W Kolari 3th, 2005, also study the simulation and ALM Simulation model can combine the best features

of dollar gap analysis and other factors that bank wants to consider and

it is a flexibility model that can reveal the effects on income and equity

of large change interest rate which other model cannot process

According to The Basel committee on banking supervision,

2004, which was established by central bank governors of the group ten countries in 1975, they also address some interest rate measurement techniques including repricing schedules with gap and duration analysis, simulation approaches The various measurement approaches have their strengths and weaknesses in terms of providing accurate and reasonable measures of interest rate exposure

In a paper of Bank of Jamaica (1996), it present the necessary of setting out the policies and procedures for manage the interest rate risk within the context of comprehensive business plan Each institution should use at least one of three technique of interest rate measurement and preferably a combine of gap, duration and simulation

Thosmas J Linsmeire and Neil D Pearson (1996) introduced the concept and methodology of “ Value at risk” which is new tool for measuring an entity’ exposure market risk They express three method

of measurement that are historical simulation; the variance-covariance method; and stochastic simulation

Value at risk was first used in late 1980’ to measure the risks of their trading portfolios Since that time of period, the use of value at risk has explored

Yoshinao Kiyama, Toshihiro Yoshida, monetary and economic studies (1998) constructed Value at risk model to express the stochastic process of market rate He performed a simulation using a imaginary portfolio to analyze the factors determining interest rate risk

R.Vaidyanathan (1999) not only concerns some measurement such as dollar gap, duration gap or simulation, but also suggests Value

at risk method for measuring exposure of bank to interest rate risk in the context of India “Value at risk refers to maximum expected loss that a bank can suffer over a target horizon, given a certain confident interval” In other words, value at risk can answer the question what the maximum loss bank suffer at a certain confident interval

The measurement interest rate risk has been learned for long time

by many authors Each author had been contributed to perfect the interest rate measurement However, all of their theories are also based

on some certain assumptions dependent on condition of real context Almost theories of interest rate measurement concentrate on three methods including dollar gap, duration gap and simulation Off course,

in each method, authors can adjust their assumptions in order to get effective and accurate one

Chapter 3: Methodology

This chapter is to explain and describe the methodology of research It includes research design, data collection, and analysis for answering the research questions

3.1 Research design

Firstly, examine the type of research in terms of classification, purpose and technique, and then the research is designed as appropriate for study

The main research questions including:

How do Vietnamese banks measure interest rate risk ?

What are the advantage and disadvantage of recent interest rate risk methods?

How is interest rate risk measured with earning simulation

in context of Vietnam ?

To answer these questions, it is critical to have information as:

Main sources of interest rate risk in Vietnam

What method Vietnamese banks use to measure interest rate risk

The disadvantages and advantages of current method

Effectiveness of the recent method

Main factors impact on the performance of current method

The inappropriate contents of current interest rate risk method

Expectation of an appropriate interest rate risk measurement

When the information is collected, it means that the problem can be clarified and defined How banks can measure their interest rate risk has been investigated and described It is useful to obtain information for an exploratory research because the research can explore some appropriate methods of interest rate risk measurement

Zikmund (1997) classified research method into four types: survey; experiment; observation and secondary data In this research, survey and secondary data are chosen Survey is chosen to investigate how banks measure interest rate risk in terms of quantity, how they calculate interest rate risk Because there is lack of information of recent method used to measure it, survey is appropriate method The secondary data can be used to examine and measure the interest rate risk It can be adjusted for easily measurement, examining and illustrating the methods

3.2 Data collection

This section discusses how relevant data was collected for answering the research question Data can be described as qualitative or quantitative Qualitative data is concerned with qualities and non-numerical characteristics while quantitative data is concerned in numerical form

A qualitative approach provided a more complete view of the impression of those involved and the problem from their perspective The purpose of study is to identify the appropriate method of interest

rate risk for banking activity Hence, qualitative approach is most appropriate

For carrying out this research, the main methods used in this research are description, analytical, comparative, and exploratory

In terms of data sources, primary data and secondary data have been collected Method utilized in collecting data is document collection and in-depth interview The interviews were source of primary data whereas document collected for analysis were secondary data such as SBV’s reports, GSO reports, Vietnamese bank’s financial statements, financial bulletin and reports

3.2.1 Document collection

Documents collection was conducted from financial statements, financial bulletins; financial reports; and from other relative organizations and during interview Specially, international standard principles for management and supervision of interest rate risk was also examined and referenced

3.2.2 Personal interview

A questionnaire was designed and based on what the information

to be required reflecting interviewer actual line of inquiry The questionnaire consists of series of open-ended questions

Questionnaire for interview

What method does your bank use to identify and measure interest rate risk?

What are sources of interest rate risk in your bank?

Describe interest rate risk measurement in your bank

How does your bank react in order to limit interest rate exposure?

What are disadvantages and advantages of the current method of interest rate risk measurement?

How exactly is the current method performance?

What do main factors affect your bank’s current method performance?

What are the contents of a bank’s interest rate risk measurement that is considered being inappropriate for nature of its activities?

What are your suggestions or commendations for contributing on

a new appropriate method?

What are the main contents of a new appropriate method of interest rate risk measurement?

A questionnaire was generated form the need of information for accessing the effective of recent method interest rate risk measurement

To value the how a banks calculates their interest rate risk Researcher interviews a person who works as a member in ALCO of that bank which mainly responsible for daily important financial decisions Their answer will make clear the concern about interest rate risk management and measurement, or what they do to manage and compute interest rate risk Researcher also asks some people who are specialists in risk management field Therefore, list of interview will be established including members of bank’s ALCO and some experts in risk management

3.3 Data analysis

Analyzing case study evidence is especially difficult because the strategies and techniques have not been defined (Yin 2003) The original data will be processed in suitable form to perform data analysis

to achieve research objective

Statistic description will express the bank’s concern about interest rate risk How they compute interest rate risk; experience; effective of their method will be described Basing on expectation and objective of interest rate risk, researcher will suggest a method which is more appropriate and suitable for real condition

3.4 Conclusion

This chapter described some aspects of research methodology for this study including research design, data collection, and data analysis This study is exploratory research

Data was collected through secondary data and via personal interview Personal interview provided information of how they concern in terms of interest rate risk and how their bank measure interest rate risk In addition, secondary data provide a large of information of interest rate risk measurement Basing on that information, appropriate approach would be suggested for applying in real condition of Vietnam

Chapter 4: Analysis and findings 4.1 Introduction

As indicated in Chapter 1, the objectives of the research are to identify an appropriate tool for interest rate risk measurement The research is designed to answer the questions that how Vietnamese banks measure their interest rate risk and what are the advantages and disadvantages of the method they use and how the income simulation method is used as the appropriate method to measure interest rate risk for Vietnamese banks

The results of data analysis and findings links to research questions and research objectives, which are mentioned above The information of data analysis will describes what the banks do to measure the interest rate risk The contents of the recent method are analyzed in order to point out weaknesses The information from the survey interprets, in general, the method used and how effectively they compute the effect of interest rate fluctuation to interest income The study also mentions the experiences of some banks in Vietnam in terms

of interest rate risk management The effectiveness of the recent tools used and the expectation from a new method will be expressed as well From the information of analysis, researcher suggests that income simulation is an appropriate method for measurement interest rate risk

in Vietnamese banks