In recent years, we have seen a very rapid increase in outstanding bank deposits. This increase has been particularly high since the outbreak of the COVID 19 pandemic, due to the lockdown that has, among other things, drastically reduced household consumption since the beginning of March 2020. This very sharp increase in outstandings increases the risk of banks which offer interest on deposits. In this paper, we deal with the mitigation of the risk contained in interest rate margins of demand deposits. We introduce and analyze hedging strategies of an asset and liability manager who focuses on the bank’s net operating income in a given quarter under standard accounting rules. Demand deposits are assumed to be correlated with market interest rate and to a commercial risk that cannot be fully hedged on the financial markets. We distinguish several types of dynamic hedging strategies based on both quadratic and quantile criteria. We provide explicit formula for all hedging strategies and we discuss their respective robustness. We show in particular that the quantile hedging criterion leads to somewhat riskier strategy since its gain may be nil, due to its knockout feature. We argue that our contribution establishes a stronger basis for the coverage of bank deposits, which is particularly important in the context of the COVID-19 pandemic and its economic consequences.
This paper deals with risk mitigation of interest rate margins related to banks demand deposits. We assume that demand deposits are linked to interest rates and business risk, which cannot be fully hedged on financial markets. The dynamics of forward market rates follows a standard market model (i.e. BGM model). The demand deposit is the monetary amount put in to account by clients. It is accounting in M1 (monetary aggregate 1). Using a linear regression, the deposit rates are related to the market rates in linear ways. We take the viewpoint of an asset and liability manager focusing on the bank's net operating income at a given quarter according to standard accounting rules. We use the static hedging strategies for bank deposit. We illustrate our results using data from 1997 -- 2019 for both US and Euro zones. This allows us to illustrate and compare the hedging of the interest rate margin for these two main zones, for which the deposit rate setting are clearly different (roughly speaking, in the US zone the deposit rate is equal to about half of the interest rate while, in the Euro zone, the two rates are much closer).
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