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– reinvestment risk
– refinancing risk
– price risk
Interest Rate Exposure and Earnings
• First we will to look at a model that focuses on the
bank’s earnings stream. Here we will look at the
effects of interest rate changes on interest income and
interest expense. To do this, we need to look at rate
sensitive assets and rate sensitive liabilities. Using
these, we will compute a dollar measure, the GAP, of
interest rate exposure.
• Method:
– Group assets and liabilities into time "buckets” according
to when they mature or are expected to re-price
– Calculate GAP for each time bucket
– Funding GAPt
= $ Value RSAt - $ Value or RSLt
• where t = time bucket; e.g., 0-3 months
The GAP Model
• Rate-Sensitive Assets
– Short-Term Securities Issued by the Government and
Private Borrowers
– Short-Term Loans Made by the Bank to Borrowing
Customers
– Variable-Rate Loans Made by the Bank to Borrowing
Customers
• Rate-Sensitive Liabilities
– Borrowings from Money Markets
– Short-Term Savings Accounts
– Money-Market Deposits
– Variable-Rate Deposits
Traditional static GAP analysis
1. Management develops an interest rate forecast
2. Management selects a series of “time buckets” (intervals) for
determining when assets and liabilities are rate-sensitive
3. Group assets and liabilities into time "buckets" according to
when they mature or re-price
– The effects of any off-balance sheet positions (swaps, futures,
etc.) are added to the balance sheet position
– Calculate GAP for each time bucket
– Funding GAPt = $ Value RSAt - $ Value or RSLt
1. Management forecasts NII given the interest rate environment
Factors affecting NII
• Changes in the level of interest rates
∆ NII = (GAP) * (∆ i exected)
Funding GAP
GAP = $RSA - $RSL
In this example:
GAP1y = $0.00 - $10,000 = - $10,000
This is a negative GAP.
Implied options:
10,000 4yr loan, financed by a 1 yr CD
(.5)
ALCO Guideline
(1.0)
Board Limit
(1.5)
(2.0)
(2.5)
(3.0)
(3.5)
- 300 -200 -100 ML +100 +200 +300
Ramped Change in Rates from Most Likely (Basis Point)
1.0
Sensitivity of Earnings: Year Two
.5
2
Change in NII ($MM)
(.5)
ALCO Guideline
(1.0)
Board Limit
(1.5)
(2.0)
(2.5)
(3.0)
- 300 -200 -100 ML +100 +200 +300
Ramped Change in Rates from Most Likely (Basis Points)
Earnings at risk