Capital Markets Examiner School, Providence, RI

Why are earnings-at-risk and GAP not enough?

 Earnings-at-risk and GAP are tools that only measure short-term interest rate risk.

 Earnings-at-risk simulations usually only project the change in interest income one-year into the future. And the typical gap measurement is the “one-year cumulative gap”.

 But what about potential risk beyond one-year?

Economic Value of Equity (EVE) at risk

 To evaluate long-term IRR, an economic perspective is necessary.

 Focus on the value of the bank in today's interest rate environment and that value's sensitivity to changes in interest rates. This concept is known as Economic Value of Equity (or EVE) at Risk.  Requires a complete present value balance sheet to be constructed. This is done by scheduling the cash flows of all assets and liabilities and applying a set of discount rates to develop the present values. The economic value of equity (EVE) is the difference between the present value of assets and liabilities. (Equity = Assets - Liabilities).