On the Risk Management of Demand Deposits and Interest Rate Margins
This paper examines the risk management challenges associated with demand deposits, focusing on how banks manage interest rate margins in an environment of fluctuating rates. The study develops a framework for analyzing the sensitivity of demand deposit portfolios to changes in the yield curve.
Abstract
Demand deposits represent a significant liability for commercial banks and pose unique challenges for asset-liability management. Unlike term deposits, demand deposits have no fixed maturity, making their duration uncertain and their sensitivity to interest rate movements difficult to model.
This paper proposes a methodology for estimating the effective duration of demand deposits and examines how banks can optimize their interest rate margins while managing the associated risks. The empirical analysis draws on data from European banking institutions over a ten-year period.
Key Findings
The results suggest that traditional approaches to demand deposit modeling systematically underestimate duration risk, particularly in low-interest-rate environments. The paper proposes an adjusted framework that better captures the behavioral characteristics of depositors and provides more robust estimates for risk management purposes.