I have to admit - I’m tired. Not physically, I’ve had a great summer of travel and vacation. I’m tired of this sad old argument against using EVE-at-risk to measure sensitivity. I hear it all the time, “I’m not going to liquidate the bank – so this ‘EVE-at-risk’ thing just isn’t a useful measurement!”
Not about the ‘liquidate the bank” part, but about the “EVE-at-risk not being useful” part.
If you don’t believe me then answer this: If you are the investment officer for the bank, which investment is less risky from an interest rate risk (IRR) perspective?
A) 3-month treasury
B) 5-year treasury
Don’t consider credit or liquidity risk, just IRR. Which investment is less risky? I hope your answer is that “it depends” on a number of factors. What do you want to protect – earnings or value? Are rates currently rising or falling? etc.
If you only use an earnings simulation to capture IRR then the chances are you’re not capturing all of your risk. If you choose option “B” and you fund the investment with 5-year CDs then you’ve locked in income and expense for five years. Even a two or three year forecast and an earnings stress-test will show little or no earnings-at-risk. But, does that mean there’s no interest rate risk?
Here’s a different way to look at it. If you choose to buy a 5-year treasury are you impacting your bank’s interest rate risk? I think the obvious answer is yes. To date the best tool to capture this exposure across the entire balance sheet is by measuring EVE-at-risk.
It doesn’t have anything to do with “liquidating the bank”.