Fixed-Rate PIBs Funded by Short-Term Deposits
The treasury of a mid-sized Pakistani bank holds PKR 3.5 billion of 5-year fixed-rate Pakistan Investment Bonds yielding 11%, with modified duration of 4.2 years. The portfolio is funded mainly by 3-month fixed deposits at 9.5% and some low-cost CASA. The monetary policy committee is expected to raise the policy rate by 200 basis points at the next meeting. The bank's LCR is 108% and NSFR 104%. Separately, a corporate customer's import payment has left the bank with a net open FX position of USD 14 million against an internal limit of USD 10 million. The dealer wants to hold the PIBs because the yield is 'attractive' and to buy dollars spot after the payment settles tomorrow. The ALCO meets this afternoon.
1. Estimate the market value impact of a 200 bp rise on the PIB portfolio and explain the net interest margin pressure.
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Using the duration approximation: change in value ≈ -modified duration × change in yield × market value = -4.2 × 0.02 × PKR 3.5 billion = -PKR 294 million. That is a material unrealised loss relative to the portfolio.
The funding side is short-term: 3-month deposits reprice quickly, so a 200 bp policy rise could add roughly 200 bp to funding cost on the repricing portion. The PIB coupon is fixed at 11%, so asset yield does not rise with the policy rate. The net interest margin is therefore squeezed from both sides: higher deposit cost and a capital loss on the bond portfolio. The dealer's 'attractive yield' argument ignores the duration risk.
2. What ALCO actions would you recommend?
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ALCO should not hold the entire fixed-rate portfolio on a yield view. Options include selling part of the portfolio, shortening duration, entering a receive-fixed/pay-floating swap to convert fixed exposure to floating, or funding the portfolio with longer-term liabilities. A hold-to-maturity classification may reduce accounting volatility but does not remove economic risk.
I would recommend reducing duration and setting a stop-loss or risk limit for the portfolio. The bank should also stress-test the NIM and liquidity position under a 200 bp rise. With LCR at 108% and NSFR at 104%, the bank has limited headroom, so any hedge or sale should preserve high-quality liquid assets rather than consume them.
3. How should the FX limit breach be handled and reported?
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The bank should cover the excess USD 4 million immediately at the prevailing market rate and bring the net open position within the USD 10 million limit. It should not wait for tomorrow's settlement or speculate on the exchange rate. The treasury head and ALCO should be informed, and the breach should be reported under the bank's internal escalation and regulatory reporting procedures.
The cause should be investigated: whether the payment was processed without a pre-deal check, whether the limit was monitored intraday, or whether the customer's payment was not matched by a cover trade. The bank should tighten pre-deal limit checks and document the breach and remediation.