How to Calculate Interest Rate Risk in Your Loan Portfolio

Estimated reading time: 3 minutes

The interest rate risk calculator below illustrates how we calculate the risks on future financing costs of a sample loan portfolio. We use the last available risk free rate of a specific country and credit spreads as observed in the market. In this example we use the Solvency IIstandard formula as provided by EIOPA. However we can use other models as well.

The article Loan Portfolio Interest Riskshowcases how we apply the method in municipalities. The same process can be applied to the loan portfolio of any organisation.

If you want to receive more information about our risk reporting services do not hesitate to contact us. We are happy to tell you more about our financial risk reports, and what they contain.

Please hold on while the application is loading below. Then press ‘Load Sample Portfolio’ to obtain a view on the risks of a portfolio of loans..

Assumptions

For this interest rate risk calculator we use publicly available interest and credit spread data as published by central banks. We derive the implied rating by comparing the credit spread paid at the start date of the loan with the credit spreads in the market at that moment in time. The current credit spread is estimated by taking the current credit spread on the implied rating adjusted for the last known difference between the credit spread on the loan and the credit spread on that implied rating.

The methodology to calculate the risks is based on the Solvency II Standard Formula model as provided by Eiopa. This organisation calculates the stress parameters using long historical datasets and calibrates them every few years. The Solvency model prescribes a fixed correlation between interest rate and credit spread shocks. For upward shocks we need to use 0% correlation, for downward shocks 25%.

We extend the use of the model to cover longer horizons (4 vs 1 year) and multiple confidence levels (80, 90, 95, 99% vs 99,5%). To be able to extend the horizon we assume normal distributions. A 90% confidence percentile means that there is a 90% statistical chance that the risk would not be higher than the calculated level. This would entail a 10% chance that it would be higher. We validate the accuracy of this model in the article model validation interest rate risk Solvency II.

Disclaimer

We have made every attempt to ensure that the interest rate risk tool uses reliable data sources. That it applies the model properly and executes the calculations correctly. We believe this is the best available proxy of the risks based on publicly available data.

Asset Mechanics is not responsible for any errors or omissions by providers of the market data, or for results obtained from the use of this information. All information on this website is provided “as is” and for educational purposes. We do not guarantee completeness, accuracy, timeliness or the results obtained from the use of this information. The information on this website is not intended to be a source of advice or credit analysis with respect to the material presented. The information and/or documents contained in this website do not constitute investment advice.