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An Examination of Interest Rate Risk Management in Croatia: Does Bank Size Matter?

Interest rate risk arises from the maturity mismatch of a bank's assets and liabilities and off-balance positions and interest rate mismatch. It presents the danger that oscillations in interest rates will adversely affect bank earnings and the value of its assets, liabilities and capital. Even though interest rate risk management is more slowly developed in transition countries, in last decade banks in Croatia became also confronted with changes in bank environment to which they need to adjust. To satisfy demand in the more and more competitive environment, banks allow loans, take deposits, purchase securities and make their other financial activities with different maturities and interest rates. So, each of this banking activities affect its exposure to the interest rate risk. Bank can not entirely eliminate interest rate risk, but can at least substantially decrease its vulnerability due to adverse movements in interest rates. It can use different techniques and methods to manage and hedge interest rate risk. Successful risk management can improve bank performance. Sound interest rate risk management practices in banks involve (Basel Committee on Banking Supervision, 2003): appropriate board and senior management oversight of interest rate risk, adequate risk management policies and procedures, appropriate risk measurement, monitoring and controls function and comprehensive internal controls and independent audits. The manner in which a bank applies these elements depends upon the complexity and nature of its activities and on the level of the bank exposure to interest rate risk. The interest rate management system in Croatia was analysed by conducting the survey among Croatian banks. The selection of questions was made on the basis of literature review dealing with this topic. The survey was conduct among all Croatian banks, meaning 33 active banks. The conducted survey has several goals. Firstly, to analyse how much are banks in Croatia concerned with interest rate risk and who is responsible for this area. Secondly, to analyse do banks and in what level use financial derivatives to hedge interest rate risk, especially considering the bank size. Results of the research conduct among Croatian banks show that only large banks have prescribed all components of sound and effective interest rate risk management. All Croatian banks have interest rate policy, but also that all banks haven't developed interest rate risk management system. Regarding different measurement methods, the most of the banks in Croatia use the simplest method of interest rate risk management. GAP management is the most often used interest rate hedging strategy. Banks can use different interest rate hedging techniques to deal with volatile interest rates. All large and medium-sized banks use asset-liability management techniques. Besides applying different asset-liability management strategies, banks also provide loans and collect deposits with fixed or floating interest rate to hedge interest rate risk. In the last few decades financial derivatives became important instruments for hedging interest rate risk in banks, but mostly in developed countries. Derivatives could be very powerful tool for risk management, but also, if they are used in speculative manner, can increase banks risk exposure. Derivatives are concentrated only among the largest banks in Croatia. However, all large and medium-sized stated that they plan to use financial derivatives in the near future. Such results imply that lack of interest rate risk management is associated with the bank size, but also caused by the problems within the financial system. As the key restraints for higher use of derivative all banks find undeveloped financial market.

banking sector; interest rate risk; derivatives

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