Economic Value of Equity (EVE)

Economic value of equity (EVE) is the present value of all of a bank's expected cash flows from assets, minus the present value of the expected cash flows on its liabilities, with off-balance-sheet positions such as swaps included. The key measure is the change in EVE, or ΔEVE, when rates are shocked. It shows how much the long-run value of the bank's balance sheet would rise or fall if rates moved, and is one of the two main metrics used to manage interest rate risk in the banking book (IRRBB).

EVE complements earnings-based measures. Changes in net interest income show the effect of rates on profit over the next year or so, while EVE captures the effect over the whole remaining life of the banking book. A bank can look safe on one measure and exposed on the other, which is why supervisors ask for both.

Imagine you own a block of flats with a long fixed-rate mortgage and leases that also fix rents for years. If interest rates jump, buyers would pay less for a building whose rents are locked at old levels. Your mortgage also becomes cheaper in today's money, but if the rents are fixed for longer than the mortgage, the building loses more value than the debt does, and your share shrinks.

EVE applies that idea to a bank. It values everything the bank is owed and everything it owes at today's interest rates, and the difference is what the bank's owners hold in economic terms. Shocking rates up or down and recalculating shows how much of that value would be lost, even before any loss shows up in the accounts.

The basic definition is:

and the risk measure is:

Suppose a bank's assets have a present value of $1,000 million and its liabilities $900 million, so EVE is $100 million. Under a 200 basis point parallel rise in rates, long fixed-rate mortgages and bonds lose 6 per cent of their value, falling to $940 million, while shorter-dated liabilities lose 3 per cent, falling to $873 million. Shocked EVE is $940 million − $873 million = $67 million, so ΔEVE is −$33 million, a fall of 33 per cent. The loss arises because the assets have a longer duration than the liabilities. Banks often break the result down by maturity using basis point values.

• Non-maturity deposits. Current and savings accounts have no contractual maturity, so banks model how long balances stay and how fast rates reprice, using assumptions such as deposit beta. Treating stable retail deposits as long-lived liabilities reduces measured EVE risk, so supervisors cap the assumptions.
• Prepayments and options. Borrowers may repay fixed-rate loans early when rates fall, through prepayment, and depositors may withdraw term deposits, which changes cash flows in each scenario.
• Equity and margins. The bank's own equity is excluded from liabilities, and regulatory EVE measures may exclude commercial margins from cash flows.
• Discount curve. Cash flows are usually discounted using a risk-free or swap curve rather than each instrument's own rate.

The Basel Committee on Banking Supervision set out IRRBB standards in 2016 that require banks to calculate ΔEVE under six standard rate shock scenarios: parallel up, parallel down, steepener, flattener, short rates up and short rates down. Supervisors apply an outlier test that flags a bank whose worst ΔEVE loss exceeds 15 per cent of its Tier 1 capital. The European Union has turned this into binding supervisory outlier tests for EVE and net interest income through European Banking Authority standards. In the United States, there is no capital charge for IRRBB, but supervisors expect banks to measure EVE sensitivity as part of interest rate risk management, and the 2023 regional bank failures increased attention to it. Because EVE reflects the full balance sheet at market rates, it also shows the economic effect of unrealised losses on securities portfolios that accounting may not recognise.

EVE depends heavily on behavioural assumptions that cannot be observed directly, and small changes in deposit or prepayment models can swing results. It is a static, run-off view that ignores new business and how management would respond. It also gives no direct reading of profit, which is why banks pair it with measures of net interest margin and earnings sensitivity, and with analysis of yield curve risk beyond the standard shocks.

• Basel Committee on Banking Supervision: Interest rate risk in the banking book (2016)