Mind the Income Gap - Partial Hedging of Interest Rate Risk within Banks' Business Model

Abstract

We implement a recently established approach to investigate interest rate risk of banks with extensive engagement in maturity transformation. Therefore, we contribute to the emerging literature contradicting modern banking theory's view on interest rate risk as inevitable consequence of banks' maturity mismatch. We find evidence for an alignment of banks' interest income and expense sensitivities which might indicate an implied interest rate risk hedge by their business model. Banks with lower expense sensitivities show significantly higher loan maturities and higher loan proportions in their balance sheets. However, we also confirm a remaining exposure to changing market rates. Our results shed light on an implicit hedging mechanism within the traditional business model of banks, its (in)completeness, and consequences for adequate regulation.