Module: | MODULE B: RISK MANAGEMENT
Q348: Consider the following statements regarding Basis Risk in a bank's Asset Liability Management (ALM) framework:
1. Basis risk arises when the interest rates of various assets and liabilities change in different magnitudes, even if they have the exact same repricing maturity.
2. A bank funding a portfolio of loans linked to the RBI Repo Rate using deposits linked to the 1-year Treasury Bill yield is entirely immune to basis risk.
3. Basis risk is considered a specific sub-component of the broader Interest Rate Risk in the Banking Book (IRRBB).
2. A bank funding a portfolio of loans linked to the RBI Repo Rate using deposits linked to the 1-year Treasury Bill yield is entirely immune to basis risk.
3. Basis risk is considered a specific sub-component of the broader Interest Rate Risk in the Banking Book (IRRBB).
✅ Correct Answer: B
The correct answer is B. Statement 1 is correct: Basis risk is the risk that the interest rates on different instruments (assets and liabilities) will change by different amounts, even if they share the exact same maturity or repricing bucket.
Statement 3 is correct: Basis risk, along with gap risk and yield curve risk, is one of the three primary sub-components of Interest Rate Risk in the Banking Book (IRRBB) as defined by Basel and RBI guidelines.
Statement 2 is incorrect: Funding an asset linked to one benchmark (Repo Rate) with a liability linked to a completely different benchmark (T-Bill yield) is the textbook definition of creating basis risk.
Because these two rates are not perfectly correlated and move at different velocities, the bank's net interest margin is exposed to severe basis risk.
It is absolutely not immune.
Statement 3 is correct: Basis risk, along with gap risk and yield curve risk, is one of the three primary sub-components of Interest Rate Risk in the Banking Book (IRRBB) as defined by Basel and RBI guidelines.
Statement 2 is incorrect: Funding an asset linked to one benchmark (Repo Rate) with a liability linked to a completely different benchmark (T-Bill yield) is the textbook definition of creating basis risk.
Because these two rates are not perfectly correlated and move at different velocities, the bank's net interest margin is exposed to severe basis risk.
It is absolutely not immune.