VaR Model With Its Implication And Application On The Interest Rate Risk Management Of Commercial Bank Of China

Interest rate risk arises when changes of interest rate cause uncertainties in the value of financial assets. As most of the assets held by commercial banks are financial asset, changes of interest rate will directly affect the values of such financial assets; therefore, directly affect the profitability and stability of banking operation. Market-determined interest rate is one of the most content of financial innovation after China has entered WTO. Realization of market-determined interest rate is to establish the interest rate system dominated by demand and supply, and emphasizes the function of market in smoothing the economy and appropriate resource allocation. However, in the process of realizing market-determined interest rate, the fluctuation of interest rate has exacerbated and become a significant threaten to the stability of banking operation in our country. As the steps of realizing the market-determined interest rate accelerate, interest rate risk has become the most important risk facing the commercial banks. Therefore, as to guarantee the stable and healthy operation of banks, how to effectively strengthen the management on interest rate risk has become an important challenge for our commercial banks.However, as our commercial banks has always been in the environment of interest rate restriction in the past, interest rate risk has not so obvious as today that commercial bank has no sense in management of interest rate risk. Besides, as management on interest rate risk is a systematical and technical project, it is still on the way to establish a management system on interest rate risk according to the specialty in China. All of these contribute to the fact that our commercial banks do not have a complete acknowledge about the risk management on interest rate risk, and lack of an efficient risk measurement tool. However, accurate risk measurement is the foundation for the efficient risk management. Thus, as to our commercial banks, to import and analysis the advanced risk measurement model in banks of western countries will have great sense of utilization in establishing our risk measurement model.As the major risk measurement tool in western countries, VaR model has widely used in the fields of banks, securities, and derivatives. What's more, Basel Committee definitely stated that VaR model should apply in the management on interest rate risk, and make capital adequacy requirement based on VaR estimates. And as being a member country of WTO and Basel Committee, commercial banks in our country should endeavor to match the international standard in risk management. Therefore, it is of significant sense in theory and practice by analyzing the basic framework and logic underlying VaR model to establish a characterized risk measurement system appropriate for our commercial banks, which is helpful in minimizing and controlling the increased interest rate risk.Therefore, based on the topic of risk management on interest risk rate in the environment of market-determined interest rate, this article firstly analyses the current interest rate risk facing our commercial banks and the its current risk management, then points out the deficiencies of our risk management on interest rate risk and the underlying reasons. Based on this point, by introducing the VaR model theory in detail, and quoting the Deutsche bank utilization of VaR method, this article tries to discuss the applicability of VaR model in our commercial banks.Based on above frame, the first part of the article states the current interest rate facing the commercial bank in the certain environment of financial innovation. Generally, it could be concluded as two kinds of risks that face the commercial banks: periodical risk and permanent risk, with the former constituting the main sources of interest rate risk at present. Both the frequent macroeconomic policies and structural imbalance of commercial bank itself determine the huge exposure in interest rate risk. Thus it is necessary for our commercial bank to introduce advanced risk measurement model to deal with such risk.Thus, the second part of this article elaborately states the theory framework and calculating methods of VaR methods. It measures the maximum loss that a portfolio could experience in a certain holding period with a certain confidence level. Its statistical expression is as follows:ProbVaR aggregates all of the market risks in a portfolio into a single number suitable for reporting to senior management, regulators or disclosure in an annual report. Simply a way to describe the magnitude of likely losses in a portfolio results from "normal" market movements.According to different assumptions about the movement of risk factors, there are mainly 3 ways to calculating VaR, which are historical simulation, variance-covariance method and Monte-Carlo simulation. To determine the detailed calculation method should depend on the individual characteristic. However, even though its wildly use among banks, it has some shortfalls in reality. It mainly concerns the fact that VaR provides no indication on the size of losses in extreme market events or scenarios. After all, abnormally large adverse price movements are the ones that pose greatest risks to FIs. What's more, it cannot properly capture major regime changes or structural shifts in economy.The third part of the article introduces the Deutsche bank risk management system and its utilization on VaR model. After taking a analysis on its risk report, it is concluded that its efficient risk management system is established on clear managing structure, complete database, and advanced risk measurement model. By effectively combining VaR model and its certain characteristics, Deutsche bank utilizes different VaR estimates in different levels to reflect its risk exposure. Meanwhile, according to the consolidated VaR estimates, the risk manager could have a good picture of the total risk exposure in interest rate risk.Nevertheless, compared to the advanced risk measurement method, it is still in an early state for our commercial banks to utilize VaR model deeply and widely. Thus, the final part of this article pays much attention to discuss the applicability of VaR model in our commercial bank. It is certain that utilization of VaR in our commercial bank will have great impact on our risk management. It shows in the following aspects: the use of VaR model will help us quantify the risk exposure; it could effectively measure the market risk raised in financial derivatives; and it could better manage the market risk generated in dealing with the bad assets. Even though there are some barriers for the widely use of VaR model in our commercial banks, such as inadequate data, inefficiency of interest rate market, and the low correlation between returns of assets, VaR method will necessarily play a significant role in management of interest rate risk in our commercial bank, as the financial bank grows to be complete and healthy. Besides, financial government office in our country should place some policies, which aim at encouraging commercial bank to adopt VaR method, and helping remove the current restrictions and barriers for VaR method.