Banks' option to lend, interest rate sensitivity, and credit availability

Interest rate risk is a major concern for banks because of the nominal nature of their assets and the asset-liability maturity mismatch. This paper proposes a new way to derive a bank's interest rate sensitivity, by examining separately the effects of interest rate changes on existing loans(loans-in-place) and potential loans (loans-in-process). A potential loan is shown to be equivalent to an American option to lend, and is valued using option …