Liquidity risk and interest rate risk on banks: are they related?

The present study aims at ascertaining whether a relationship exists between the liquidity risk and the interest rate risk of credit institutions. By analysing the balance sheet of a small Italian bank during the years 2009 and 2010, we outlined its liquidity profile, the variables that influenced its dynamics and their effects on the bank’s global management, with particular attention to the interest margin and the interest rate risk in the banking book. We would like to fill a gap identified in the literature, shedding light on how a set of decisions designed mainly to reduce the liquidity risk and comply with the new parameters established by the Basel III Framework enables a more effective management of the regulatory capital and helps the bank to achieve a solid balance between profitability and solvency. Our main findings demonstrate that the bank succeeded in modifying its liquidity profile in order to comply with the incoming constraints imposed by the Basel III framework; the actions taken to reduce the liquidity risk also lowered its interest margin, but also enabled the bank to reduce the amount of capital absorbed by the interest rate risk, giving rise to a globally positive effect.