Early work: the Beverly subgroup

The BCBS was fully aware that the Basel Accord (1988) focussed almost entirely on credit risk, and indicated that it would undertake further work on interest rate risk and the investment risk on securities. Indeed, work on the assessment of such risks had begun several years earlier. Once again, the initial major paper on interest rate risk was put to the BCBS by a Dutch representative, Hugo Coljé, in mid-1985 (BS/85/36).

At this point, it may be helpful to explain that there are several facets to interest rate risk. One facet relates to maturity transformation. Banks normally lend for longer periods than they borrow. If we assume that the relevant interest rates are fixed for the duration of such borrowing/lending, then an (unforeseen) rise in interest rates will raise the cost of borrowed funds, in the interim before the loan matures, thereby reducing net interest income. Of course, both claims and liabilities may have rollover dates (at which the interest rate can be reset), or have variable rates, or be hedged, for example by interest rate swaps. So the maturity transformation related to interest rate risk measures the time elapse until the next readjustment of interest rates, which will be at most equal to, but often less than, the maturity adjustment ladder relevant for liquidity considerations, which were being simultaneously reviewed by the Musch committee on liquidity at the time (see Chapter 9). Such an interest-rate repricing maturity transformation ladder can either come in a stock or a flow representation, though both should, if done correctly, come to exactly the same result. An illustrative example (Annex 2 of BS/87/34) is reproduced here as Appendix A to this chapter. Both the initial Coljé note and a supporting note drafted by one of his Belgian colleagues, Pierre Dubois of the Commission Bancaire (BS/86/3), focussed entirely on this facet of interest rate risk.