What does a bank's "interest rate risk" encompass?

A bank's "interest rate risk" refers specifically to the potential for financial loss arising from fluctuations in interest rates that impact a bank's net interest income. This aspect is crucial for banks since they earn income from the interest on loans they provide and pay interest on deposits, which means any changes in interest rates can significantly affect their earnings.

When interest rates rise or fall, the rate at which a bank can lend money or the rate it pays on deposits may shift, creating a risk that these changes will negatively impact the bank’s profitability. Effective management of interest rate risk is essential for maintaining financial stability and ensuring that the bank remains capable of meeting its ongoing obligations and strategic goals. This makes understanding and mitigating interest rate risk a fundamental aspect of banking operations and financial management.