Financial intermediaries transform assets with certain risk characteristics into assets with othe... more Financial intermediaries transform assets with certain risk characteristics into assets with other risk characteristics. We define net asset transformation from liabilities to assets in terms of the pricing characteristics of contingent claims. Maturity transformation can be defined as a special case, across the whole balance sheet or locally to one contract type. We present and summarise a new rich dataset on the balance sheet asset and liability exposures of large European banks that submitted to the European Banking Authority’s EU capital exercise. In particular, we show that these banks transform short-term customer deposits and 1-5 year hybrid and subordinated debt liabilities into loan assets with greater than 5 years’ maturity. The value-weighted average maturity of the assets of these banks exceeds their liabilities by 2.07 years, with standard deviation 1.44 years. Given the importance of loan assets among these banks for determining interest rate risk, we describe and measure the interest rate risk of their loan portfolios. We find that their loan assets are primarily allocated to households and non-financial corporations in the Euro area. We critically assess the interest rate repricing risk in these loan portfolios under five simple methods, including the Basel Committee guidelines on interest rate risk assessment. We identify four major limitations in the Basel Committee guideline method and illustrate the size of the approximations they introduce through examples. Using these five methods, we measure the extent to which a standardised 200 basis point parallel interest rate shock affects the values of their loan portfolios. We find that simple loan-specific pricing models provide different, and presumably better, rankings of the relative interest rate riskiness of bank loan portfolios than the Basel Committee guideline method.
Financial intermediaries transform assets with certain risk characteristics into assets with othe... more Financial intermediaries transform assets with certain risk characteristics into assets with other risk characteristics. We define net asset transformation from liabilities to assets in terms of the pricing characteristics of contingent claims. Maturity transformation can be defined as a special case, across the whole balance sheet or locally to one contract type. We present and summarise a new rich dataset on the balance sheet asset and liability exposures of large European banks that submitted to the European Banking Authority’s EU capital exercise. In particular, we show that these banks transform short-term customer deposits and 1-5 year hybrid and subordinated debt liabilities into loan assets with greater than 5 years’ maturity. The value-weighted average maturity of the assets of these banks exceeds their liabilities by 2.07 years, with standard deviation 1.44 years. Given the importance of loan assets among these banks for determining interest rate risk, we describe and measure the interest rate risk of their loan portfolios. We find that their loan assets are primarily allocated to households and non-financial corporations in the Euro area. We critically assess the interest rate repricing risk in these loan portfolios under five simple methods, including the Basel Committee guidelines on interest rate risk assessment. We identify four major limitations in the Basel Committee guideline method and illustrate the size of the approximations they introduce through examples. Using these five methods, we measure the extent to which a standardised 200 basis point parallel interest rate shock affects the values of their loan portfolios. We find that simple loan-specific pricing models provide different, and presumably better, rankings of the relative interest rate riskiness of bank loan portfolios than the Basel Committee guideline method.
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Papers by Giuseppe Loiacono