Question

What makes a bank’s assets or liabilities rate-sensitive?

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Answer 1

A bank’s assets can be composed of bonds such as government treasuries or corporation bonds and commercial papers. When the market interest rate changes, the yield on these bonds also changes accordingly as per the market interest rates.

The bond price and yield have an inverse relationship wherein the price of the bond increases when the market interest rate decreases. Similarly, the bond price decreases when the market interest rate increases.

Also, the regulations dictate that bank “mark to market “their assets. So if the price of the bonds increases, the asset values increases and if the price of the bonds decreases, the value of asset decreases. Thus the assets of the bank are sensitive to market interest rates.