Rethinking economic capital management through the integrated derivative-based treatment of interest rate and credit risk


This research revisits the economic capital management regarding banking books of financial institutions exposed to the emerging market sovereign debt. We develop a derivative-based integrated approach to quantify economic capital requirements for considered jointly interest rate and credit risk. Our framework represents a major contribution to the empirical aspects of capital management. The proposed innovative modeling allows applying standard historic value-at-risk techniques developed for stand-alone risk factors to evaluate aggregate impacts of several risks. We use the time-series of credit default swap spreads and interest rate swap rates as proxy measures for credit risk and interest rate risk, respectively. An elasticity of interest rate risk and credit risk, considered a function of the business cycle phases, maturity of instruments, creditworthiness, and other macroeconomic parameters, is gauged by means of numerical modeling. Our contribution to the new economic thinking regarding the interest rate risk and credit rate risk management consists in their integrated treatment as the dynamics of interest rate and credit spreads is found to demonstrate the features of automatic stabilizers of each other. This research sheds light on how financial institutions may address hedge strategies against downside risks. It is of special importance for emerging markets heavily dependent on foreign capital as it potentially allows emerging market banks to improve risk management practices in terms of capital adequacy and Basel III rules. From the regulatory perspective, by taking into account inter-risk diversification effects it allows enhancing financial stability through jointly optimizing Pillar 1 and Pillar 2 economic capital.

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Source Bloomberg, authors’ calculations


  1. 1.

    The minimum capital requirements for the credit risk (CR) are discussed in Section “Capital requirements for credit risk” of the Basel Accord, see pp. 72–189 of Regulation (EU) No 575/2013 (European Parliament 2013).

  2. 2.

    As for interest rate risk (IRR) no minimum capital requirements is established under the Basel Accord, see “Interest rate in the banking book” document by Basel Committee on Banking Supervision (2016) for IRR-related standards.


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Financial support by FCT (Fundação para a Ciência e a Tecnologia), Portugal is gratefully acknowledged. This article is part of the Strategic Project (UID/ECO/00436/2013).

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Correspondence to Mariya Gubareva.

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Gubareva, M., Borges, M.R. Rethinking economic capital management through the integrated derivative-based treatment of interest rate and credit risk. Ann Oper Res 266, 71–100 (2018).

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  • Emerging markets
  • Integrated risk modeling
  • Interest rate risk
  • Credit risk
  • Downside risk management
  • Economic capital

JEL Classification

  • G15
  • G10
  • F39