Wells Fargo & Financial Meltdown of 2008

Wells Fargo & Financial Meltdown of 2008

Interest Rate Risk & Credit Risk

Interest rate risk has significant earnings impact due to which it is an integral part of being a financial intermediary (Cornyn, Cornyn, Mays, 1997). Wells Fargo is subject to interest rate risk because of market interest rates, maturity and reprise of assets and liabilities at different times or at same times, shortening or lengthening of remaining maturity of different assets or liabilities due to changes in interest rates. The interest rate risk is assessed by comparing the most possible earnings prospect with different earnings simulations using various scenarios of interest rates. The analysis of interest rate risk as of 31st December 2008 reveals that Wells Fargo's estimated earnings were at a risk of less than 1% of their most possible earnings prospect over the future twelve months involving a condition of federal funds rate increase to 4% as well as the 10 year Treasury bond yield increase to 6% (Annual Report, 2007-08). Whereas, Wells Fargo's interest rate risk for the year 2007 was estimated to be 4% at federal fund increase to 6% and 10-year treasury increase to 7%, and in 2006 was approximately 1% at federal rates decline to 2.50% and 10-year Treasury bond yield decline to 3.75% (Annual Report, 2006-07).

On the other hand, the credit rate risk which arises due to the risk of principle loss or financial reward stemming from a failure of a borrower for repaying a loan or meeting a contractual liability, is managed by the business using hedge techniques that where higher credit risk raised due to higher interest rates. So, the analysis reveals a level of spread aroused in the yields of the firm (shown by the graph below). The yield curve clearly represent the daily spread among the 10-Year CMS rate and 2-Year CMS rate of Wells Fargo from 1st January 1990 till 22 May 2009. During this period, around 0.60% of the regular spreads among both the rates were zero or else negative. However, the average daily spread during the period was 1.1154%.

Bank's Loan Loss Provision

Loan loss provision is an expense set aside for the allowance of predicted bad loans, also called valuation allowance (Laurin, Majnoni, & World Bank, 2003). The analysis of Wells Fargo reveals that throughout the years 2005 till 2008 the business demonstrated a significant amount of ...