The changes in the IRR can lead to detrimental impacts on the financial institution’s earning and economic value. To address these issues, there must be factoring in of the two complementary perspectives of assign the IRR exposure.
In the case of the earning perspective, the focus of the analysis is on the impact of the changes in the interest rates and their reported earnings. This is the conventional approach used to make the interest rate risk assessment. There are variations in earning that is an important focal point for the IRR analysis. This is based on the fact that the reduced earning can threaten the financial stability of the institution and could undermine the capital adequacy and would ultimately reduce the positive sentiments associated with the financial institutions.
The component of earning which can conventionally receive the most attention is the net interest income. The net interest income is calculated as differences between the total interest income and the total interest expense of the bank. These would reflect the importance of the net interest income of the banks earning. These are found to be direct and it can be easily applied to understand the impact of changes in IRR. The offering and the services rendered by the financial institutions are now considered based on the overall net income of all the newer factors. In this system, the non-interest income that arises from these activities is the asset securitization or the loan services. These fluctuated based on the interest rates of the market. The increased sensitivity causes the financial institutions to understand the issues from a holistic vice. Hence, the earning and estimated earnings need to be considered in the different rate environments to understand the situation from a comprehensive perspective.