Shifting the yield curve for fixed-income and derivatives portfolios

Abstract

We use granular regulatory data on euro interest rate swap trades between January 2021 and June 2023 to assess whether derivative positions of Italian banks can offset losses on their debt securities holdings should interest rates rise unexpectedly. At the aggregate level of the banking system, we find that a 100-basis-point upward shift of the yield curve increases on average the value of swaps by 3.65% of Common Equity Tier 1 (CET1), compensating in part for the losses of 2.64% and 5.98% of CET1 recorded on debt securities valued at fair value and amortised cost. Variation exists across institutions, with some bank swap positions playing an offsetting role and some exacerbating bond market exposures to interest rate risk. Nevertheless, we conclude that, on aggregate, Italian banks use swaps as hedging instruments to reduce their interest rate exposures, which improves their ability to cope with the recent tightening of monetary policy. Finally, we draw on our swap pricing model to conduct an extensive data quality analysis of the transaction-level information available to authorities, and we show that the errors in fitting value changes over time are significantly lower compared to those in fitting the values themselves.