Interest Rate Risk
What does it mean
Interest Rate Risk means the risk of changes to a bank’s cost of funds during the term of the loan. The example would be if a bank were to close a loan with a 10 year fixed rate of 5% at a time when it’s cost of funds was 0.5%. Interest Rate Risk is the risk that during some time during the 10 year term of the loan, the bank’s underlying cost of funds could change and either increase or decrease the profitability of this loan.
Why does it matter
Understanding that market interest rates and deposit rates are subject to change at anytime, a good banker should recognize the potential risk a change in interest rates can have during the term of the loan, and the farther out the fixed rate portion of a loan goes, the more of a buffer the banker should build into the interest rate being offered.
Other Relevant Terms
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