Question

    ABC Bank Ltd has extended a Rs.10 crore loan at 5% over

    the repo rate. The loan is to be repaid in equal quarterly instalments. The bank’s funding of the loan is to be done by 5 years deposit, interest rate on it being 6.5%. Which of the following risk associated with this transaction can lead to variation in the bank’s net interest income in one year?
    A Market Risk Correct Answer Incorrect Answer
    B Re-pricing risk Correct Answer Incorrect Answer
    C Embedded option risk Correct Answer Incorrect Answer
    D Funding risk Correct Answer Incorrect Answer
    E Liquidity risk Correct Answer Incorrect Answer

    Solution

    Repricing risk is  the risk of changes in interest rate charged (earned) at the time a financial contract's rate is reset . Here the interest on the loan extended (asset) is variable while that on the deposits (liability) is fixed. Any change in the interest rate will impact the net interest income by repricing of the loan of the bank and changing the net spread between interest earned and interest paid.

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