Along with the heightened sensitivity about the health of the banking sector, business media have begun reflecting a heretofore underappreciated recognition of the importance of interest rate risk management in banking. Recent reporting and editorializing leaves the impression, however, that we wouldn't be facing this onslaught of failures and rescues if only these troubled institutions had managed their risks better. There's a certain truth to that, but it's not quite that simple.

Like all commercial enterprises, banks operate in a world of uncertainty. But for banks, the realm of interest rate uncertainty is paramount because banks function both as borrowers and lenders at the same time. They borrow largely from their depositors, whom they pay interest, and they lend to individuals and companies by initiating and buying loans or other securities, thereby earning interest. Thus, they bear interest rate sensitivity on both their assets and their liabilities.