Managing Interest rate risk - A case study of four Swedish savings banks

Abstract

Savings banks differ from other types of banks, in the sense that they have noshareholders. This does however not mean that savings banks can ignore fundamental financial principles. Instead they are even more dependent on their ability to generate profits, since they cannot raise additional equity capital from shareholders or members. Furthermore the world for financial institutions has changed during the last 20 years, and become riskier and more competitive-driven. After the deregulation of the financial market in Sweden, banks had to take on extensive risk in order to earn sufficient returns. For managing the different types of risks within a savings bank, examining the standard accounting schedules is simply not enough. Asset and Liability Management is the management of both assets and liabilities simultaneously for the purpose of mitigating interest rate risk, providing liquidity and to enhance the value of the bank. Especially the effect of interest rate changes has been an important issue for the banking industry in recent years with many arguing that for example the U.S. savings and loans crisis was a result of bad interest rate risk management. Furthermore small banks, like savings banks lack the litheness of large banks when managing interest rate risk, and the management of interest rate risk varies with bank size. Earlier studies have found that savings banks have lower interest rate risk than commercial banks in Sweden, indicating that managers in savings banks seem to be more risk averse than the managers of commercial banks. This leads us to our inquiry questions: • What are the reasons for savings banks having lower interest rate risk than commercial banks in Sweden? • In what ways is the management of interest rate risk affected by the fact that savings banks have no shareholders? • What tools for managing interest rate risk are applied by savings banks and what makes them most suitable? • What are the trade-offs between benefits and costs for actively managing interest rate risk for savings banks? The purpose of this thesis is to study how and to what extent interest rate risk is managed in four Swedish savings banks. We wrote this thesis from the bank managers’ point of view and our goal was to create valuable knowledge, regarding management of interest rate risk, for managers of savings banks. We have studied four Swedish savings banks in Västra Götalands Län and how they manage interest rate risk. This is a qualitative study where we interviewed appropriate staff members from the four savings banks. We have also used books, scientific articles and databases for collection of relevant data. We found that the level of risk taking in savings banks varies between the different savings banks in our study, and the reason for savings banks having low interest rate risk is that they lack the resources and knowledge for managing higher interest rate risk efficiently. The level of interest rate risk taking is also affected by the fact that the savings banks act in a more limited and riskier markets, and have to balance the level of risk taking within the bank. Having no shareholder makes it possible for the savings banks to pursue long-term strategies and they do not need to take on more risks in order to earn higher returns. Neither are they exposed to the same pressure as commercial banks are towards the demands from their shareholders. Instead they focus on earning money on traditional banking activities and not on speculations. All the tools available for managing interest rate risk can be applied by savings banks, but some tools are more commonly used than others. The most common tools for measuring and managing interest rate risk are the gap model and interest rate swaps. There is no need for savings banks to acquire sophisticated Asset and Liability Management tools because they do not have complex balance sheets and large number of transactions, and thus the costs exceeds the benefits. Furthermore some savings banks choose to hedge their interest rate risk to such extent, making sophisticated Asset and Liability Management tools unnecessary. The main reason for savings banks having lower interest rate risk than commercial banks is due to more cautious risk policies. However there are great differences among the savings banks that cannot be explained by size and resources. Those savings banks with cautious risk policies have an embedded philosophy within the banks, which states that profits should be earned on traditional banking activities, and not on speculations.