Valuating transformation through net interest margin and asset-liability matching: The case of CFM

Résumé du document

Our thesis, entitled “Valuating transformation through net interest margin and asset-liability matching: the case of CFM”, proposes the optimization of the risk-adjusted performance of transformation thanks to interest risk management. The goal of our thesis is to evaluate the transformation in banking, and more particularly in Crédit Foncier of Monaco (CFM), which is a private bank and a subsidiary of Calyon, investment banking of Crédit Agricole. The transformation of deposits into loans is the core business of banking because this process generates a net interest margin in the profit and loss statement (P&L) but engenders financial risks reflected by the asset-liability mismatches in the balance-sheet (B/S).

Extraits

[...] The accounting methods comprise gap analysis - either traditional, normalized, generalized, discounted or simulated duration, price value of a basis point or multifactor regressions. Their target variables are volume, margin or value. By contrast, the market methods deal with constant or variable betas and their target variable is the market profitability. However, all these methods have limitations Managing risks The risk management is an arbitrage between hedging and risk exposure according to anticipations. To immunize the net interest margin to adverse interest rate variations, banks use several techniques: matching, diversification, consolidation and macro or micro hedging. [...]

[...] long term), interest rate (certain rate vs. uncertain rate) and currency (domestic vs. foreign) - are sources of three financial risks, one about quantity and two about price. The liquidity risk, stemming from the lack of marketability of an asset that cannot be bought or sold quickly enough to prevent a loss, has three forms: cushion, normal cost and extreme illiquidity. The interest rate risk, defined as the risk of loss due to variation of interest rates, derives from four sources: liquidity gap, basis or bid-ask spread risk, yield curve risk and implicit options. [...]

[...] Hedging is insured by Asset-Liability Management (ALM) and the use of hedging instruments. The main derivatives are swaps, Future Rate Agreement options, forward, futures, caps and floors. The measure of the interest rate risk is operated with different methods which all have limitations. For example, the gap analysis is altered by undetermined maturity, the duration does not take into account the convex relationship between value and interest rate, the price value of a basis point assumes a parallel shift of the interest rates, and the market methods depend on the estimation of betas. [...]

[...] The sensitivity of the net interest margin to interest rate variations is followed by Earnings At Risk MacAulay duration, Net Present Value (NPV) but also more complex models such as Nelson-Ziegel or Monte Carlo simulation for scenario analysis. Obviously, it is necessary to use the discounted cash flows and the Capital Asset Pricing Model (CAPM) for valuation Empirical background The indexation of outstanding rates on market rate is based on the correlation analysis and the variance covariance matrix. Indeed, the outstanding rates are numerous and their correlation with market rates is imperfect. [...]

[...] To evaluate the transformation in general, it is first necessary to understand the balance-sheet structure and profit & loss composition of banks, in order to point out the financial risks. Next, the review of theoretical models allows the disclosure of their advantages and limitations. To evaluate the transformation in Crédit Foncier of Monaco, it is crucial to interview professionals, and more particularly the treasurer, the risk manager and the Chief Financial Officer, so as to understand the existing methodology, obtain advices and forecast improvements. [...]