Module: | MODULE B: RISK MANAGEMENT
Q283: Consider the following statements regarding the measurement of Net Interest Income (NII) and Economic Value of Equity (EVE) sensitivity under RBI guidelines:
1. Net Interest Income (NII) sensitivity measures the short-term impact of interest rate changes on a bank's earnings over a specific time horizon.
2. Economic Value of Equity (EVE) analysis focuses solely on the trading book, completely ignoring the long-term cash flows of the banking book.
3. Under updated guidelines, banks demonstrating excess vulnerability in their EVE are required to hold additional capital under Pillar 2 of the Basel framework.
Which of the statements given above is/are correct?
2. Economic Value of Equity (EVE) analysis focuses solely on the trading book, completely ignoring the long-term cash flows of the banking book.
3. Under updated guidelines, banks demonstrating excess vulnerability in their EVE are required to hold additional capital under Pillar 2 of the Basel framework.
Which of the statements given above is/are correct?
✅ Correct Answer: B
The correct answer is B. Statement 1 is correct: The earnings perspective (NII sensitivity) focuses on the short-term horizon (typically 1 to 2 years), analyzing how changes in interest rates will affect the bank's net interest income during that period.
Statement 2 is incorrect: EVE analysis is precisely designed for the Banking Book, not the trading book.
It calculates the present value of all expected long-term cash flows from banking book assets minus liabilities, capturing structural interest rate risk across the entire life of the instruments.
Statement 3 is correct: Under RBI and Basel III IRRBB guidelines, if a bank's EVE declines by more than 15% of its Tier 1 capital under standard shock scenarios, it is deemed excessively vulnerable and must be assigned a capital add-on under the Pillar 2 Supervisory Review Process.
Statement 2 is incorrect: EVE analysis is precisely designed for the Banking Book, not the trading book.
It calculates the present value of all expected long-term cash flows from banking book assets minus liabilities, capturing structural interest rate risk across the entire life of the instruments.
Statement 3 is correct: Under RBI and Basel III IRRBB guidelines, if a bank's EVE declines by more than 15% of its Tier 1 capital under standard shock scenarios, it is deemed excessively vulnerable and must be assigned a capital add-on under the Pillar 2 Supervisory Review Process.