This document discusses interest rate risk and gap analysis for managing that risk. It defines key terms like rate sensitive assets and liabilities, funding gap, duration gap, and positive and negative gaps. It also covers traditional static gap analysis, factors that affect net interest income, and advantages and disadvantages of gap analysis. The primary purpose of gap analysis is to measure a bank's interest rate risk by comparing rate sensitive assets and liabilities over different time periods.
Because of the risk-return tradeoff, you must be aware of your personal risk tolerance when choosing investments for your portfolio. Taking on some risk is the price of achieving returns; therefore, if you want to make money, you can't cut out all risk. The goal instead is to find an appropriate balance - one that generates some profit, but still allows you to sleep at night.
Introduction to Exchange Rate Mechanism: Spot- Forward Rate, Exchange Arithmetic. -- Deriving the Actual Exchange Rate: Forwards, Swaps, Futures and Options. Guarantees in Trade: Performance, Bid Bond etc.
explain about techniques for hedging transaction exposure, how to used hedge future, option, money market for payable and receivable, comparing techniques for hedging vs not-hedging
Managerial Finance. "Risk and Return". Types of risk. Required return. Correlation. Diversification. Beta coefficient. Risk of a portfolio. Capital Asset Pricing Model. Security Market Line.
Jimmy Vercellino, an experienced professional with mortgage lender First Choice Loan Services, works hard to provide a personalized home loan process for you. Options include FHA and VA loans, fixed / adjustable rate mortgages, Jumbo loans and more. Visit http://phxhomeloan.com
First Choice Loan Services Inc.
7600 E. Doubletree Ranch Road #200
Scottsdale, AZ 85258
480-800-8387
jimmy@phxhomeloan.com
This presentation is the one stop point to learn about Basel Norms in the Banking
This is the most comprehensive presentation on Risk Management in Banks and Basel Norms. It presents in details the evolution of Basel Norms right form Pre Basel area till implementation of Basel III in 2019 along with factors and reason for shifting of Basel I to II and finally to III.
Links to Video's in the presentation
Risk Management in Banks
https://www.youtube.com/watch?v=fZ5_V4RW5pE
Tier 1 Capital
http://www.investopedia.com/terms/t/tier1capital.asp
Tier 2 Capital
http://www.investopedia.com/terms/t/tier2capital.asp
Basel I
http://www.investopedia.com/terms/b/basel_i.asp
Capital Adequacy Ratio
http://www.investopedia.com/terms/c/capitaladequacyratio.asp
Basel II
http://www.investopedia.com/video/play/what-basel-ii/?header_alt=c
Basel III
http://www.investopedia.com/terms/b/basell-iii.asp
RBI Governor - Raghuram G Rajan on the importance if Basel III regulations
https://youtu.be/EN27ZRe_28A
In The Trust Edge, David Horsager reveals the foundation of genuine success- — trust. Based on research but made practical for today’s leader, The Trust Edge shows that trust is quantifiable and brings dramatic results to businesses and leaders.
In this book, Horsager teaches readers how to build the Eight Pillars of Trust.
When leaders learn how to implement these pillars, they enjoy better relationships,
reputations, retention, revenue and results. Fascinating and timely, The Trust
Edge unveils how trust has the ability to accelerate or destroy any business, organization or relationship. The lower the trust, the more time everything takes, the
more everything costs and the lower the loyalty of everyone involved. Conversely,
an environment of trust leads to greater innovation, morale and productivity. The
trusted leader is followed. From the trusted salesperson, people will buy. For the
trusted brand, people will pay more, come back and tell others. Trust, not money,
is the currency of business and life!
Because of the risk-return tradeoff, you must be aware of your personal risk tolerance when choosing investments for your portfolio. Taking on some risk is the price of achieving returns; therefore, if you want to make money, you can't cut out all risk. The goal instead is to find an appropriate balance - one that generates some profit, but still allows you to sleep at night.
Introduction to Exchange Rate Mechanism: Spot- Forward Rate, Exchange Arithmetic. -- Deriving the Actual Exchange Rate: Forwards, Swaps, Futures and Options. Guarantees in Trade: Performance, Bid Bond etc.
explain about techniques for hedging transaction exposure, how to used hedge future, option, money market for payable and receivable, comparing techniques for hedging vs not-hedging
Managerial Finance. "Risk and Return". Types of risk. Required return. Correlation. Diversification. Beta coefficient. Risk of a portfolio. Capital Asset Pricing Model. Security Market Line.
Jimmy Vercellino, an experienced professional with mortgage lender First Choice Loan Services, works hard to provide a personalized home loan process for you. Options include FHA and VA loans, fixed / adjustable rate mortgages, Jumbo loans and more. Visit http://phxhomeloan.com
First Choice Loan Services Inc.
7600 E. Doubletree Ranch Road #200
Scottsdale, AZ 85258
480-800-8387
jimmy@phxhomeloan.com
This presentation is the one stop point to learn about Basel Norms in the Banking
This is the most comprehensive presentation on Risk Management in Banks and Basel Norms. It presents in details the evolution of Basel Norms right form Pre Basel area till implementation of Basel III in 2019 along with factors and reason for shifting of Basel I to II and finally to III.
Links to Video's in the presentation
Risk Management in Banks
https://www.youtube.com/watch?v=fZ5_V4RW5pE
Tier 1 Capital
http://www.investopedia.com/terms/t/tier1capital.asp
Tier 2 Capital
http://www.investopedia.com/terms/t/tier2capital.asp
Basel I
http://www.investopedia.com/terms/b/basel_i.asp
Capital Adequacy Ratio
http://www.investopedia.com/terms/c/capitaladequacyratio.asp
Basel II
http://www.investopedia.com/video/play/what-basel-ii/?header_alt=c
Basel III
http://www.investopedia.com/terms/b/basell-iii.asp
RBI Governor - Raghuram G Rajan on the importance if Basel III regulations
https://youtu.be/EN27ZRe_28A
In The Trust Edge, David Horsager reveals the foundation of genuine success- — trust. Based on research but made practical for today’s leader, The Trust Edge shows that trust is quantifiable and brings dramatic results to businesses and leaders.
In this book, Horsager teaches readers how to build the Eight Pillars of Trust.
When leaders learn how to implement these pillars, they enjoy better relationships,
reputations, retention, revenue and results. Fascinating and timely, The Trust
Edge unveils how trust has the ability to accelerate or destroy any business, organization or relationship. The lower the trust, the more time everything takes, the
more everything costs and the lower the loyalty of everyone involved. Conversely,
an environment of trust leads to greater innovation, morale and productivity. The
trusted leader is followed. From the trusted salesperson, people will buy. For the
trusted brand, people will pay more, come back and tell others. Trust, not money,
is the currency of business and life!
This presentations chalks out in detail information about ALM in Indian Bank. It starts with the basics of Balance sheet; applicability of ALM in real life; Evolution and then starts with main topics of ALM like structured statement; Liquidity risk, its management; currency risk and finally ends with Interest Risk management.
Links to Video’s in the ppt
Balance Sheet
http://www.investopedia.com/terms/b/balancesheet.asp
NII/NIM
http://www.investopedia.com/terms/n/netinterestmargin.asp
www.abhijeetdeshmukh.com
Interest rate risk management for banks under Basel II, presentation by Christine Brown, Department of Finance , The University of Melbourne, Shanghai, December 8-12, 2008
HomeworkMarketHow it works.Pricing.FAQ.Homework Answers.LoPazSilviapm
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How it works.Pricing.FAQ.Homework Answers.Log in / Sign up
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Bank Case Assignment
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CaseRequirements.pdf
Home>Business & Finance homework help>Bank Case Assignment
What is this Project’s Objective?
This project is designed to improve your ability to analyze a particular bank's performance. The
emphasis should be to explore your bank from a regulator’s point of view. In that respect you
should address the six CAMELS components and try to identify any "red flags" that could indicate
potential problems in your bank. The Excel file under the name of “Bank Financial Analysis”
should be used to capture the financial data for your bank and to show the associated financial
ratios. You should be able to find all your data in your bank’s Uniform Bank Performance Report
(UBPR) which is available at www.ffiec.gov. Your written report should be no less than 5 pages
long (typed, double-spaced) not including the Excel worksheet. The six CAMELS components
are: Capital adequacy; Asset quality; Management quality; Earnings record; Liquidity position;
and Sensitivity to market risk. Following is a more detailed listing of the items that you need to
address:
A. Liquidity
Consider your bank’s Uniform Bank Performance Report (UBPR) and provide an overview of your
bank’s liquidity by reviewing the following areas:
1. Liquidity and Funding Ratios especially the Net Non-Core Funding Dependence
and Loan to Assets Ratios – The first ratio measures the degree to which the bank is
funding longer-term assets (loans, securities that mature in more than one year, etc.) with
non-core funding. Non-core funding includes funding that can be very sensitive to
changes in interest rates such as brokered deposits, CDs greater than $100,000, and
borrowed money. Higher ratios reflect a reliance on funding sources that may not be
available in times of financial stress or adverse changes in market conditions. What are
the trends in these ratios? How do they compare to the peer?
2. The availability of liquid assets readily convertible to cash without undue loss-
Consider Federal funds sold, available for sale securities, loans for sale, etc.
3. Core deposit/asset growth - Are core deposits capable of funding anticipated asset
growth?
4. Diversification of funding sources - A bank with strong liquidity has a strong core
deposit base, established borrowings lines, and procedures in place for acquiring
internet-based or other forms of emergency borrowing.
5. External Forces - Economic conditions, competition, marketing efforts, etc. ...
Monte Carl Simulation is a powerful and effective tool when used properly helps to navigate the expected Net Present Value NPV. This presentation helps to improve the pattern to ackowlege onthe Odessa Investment by Decision Dres.
Proactive Alternatives strategies for the sophisticated HNW investor with actively managed accounts. A currency hedge works well against rising interest rate volatility.
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Presenting this set of slides with name - Corporate Finance Powerpoint Presentation Slides. This PPT deck displays eighty slides with in-depth research. Our topic oriented Corporate Finance Powerpoint Presentation Slides presentation deck is a helpful tool to plan, prepare, document and analyze the topic with a clear approach. We provide a ready to use deck with all sorts of relevant topics subtopics templates, charts and graphs, overviews, analysis templates. O. It showcases of all kind of editable templates infographics. You can make changes to colors, data, and fonts if you need to. Download PowerPoint templates in both widescreen and standard screen. The presentation is fully supported by Google Slides. It can be easily converted into JPG or PDF format. https://bit.ly/3pEi9qk
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Recruiting in the Digital Age: A Social Media MasterclassLuanWise
In this masterclass, presented at the Global HR Summit on 5th June 2024, Luan Wise explored the essential features of social media platforms that support talent acquisition, including LinkedIn, Facebook, Instagram, X (formerly Twitter) and TikTok.
Cracking the Workplace Discipline Code Main.pptxWorkforce Group
Cultivating and maintaining discipline within teams is a critical differentiator for successful organisations.
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What is the TDS Return Filing Due Date for FY 2024-25.pdfseoforlegalpillers
It is crucial for the taxpayers to understand about the TDS Return Filing Due Date, so that they can fulfill your TDS obligations efficiently. Taxpayers can avoid penalties by sticking to the deadlines and by accurate filing of TDS. Timely filing of TDS will make sure about the availability of tax credits. You can also seek the professional guidance of experts like Legal Pillers for timely filing of the TDS Return.
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In this comprehensive presentation, we will explore strategies and practical tips for enhancing profitability in small businesses. Tailored to meet the unique challenges faced by small enterprises, this session covers various aspects that directly impact the bottom line. Attendees will learn how to optimize operational efficiency, manage expenses, and increase revenue through innovative marketing and customer engagement techniques.
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B2B payments are rapidly changing. Find out the 5 key questions you need to be asking yourself to be sure you are mastering B2B payments today. Learn more at www.BlueSnap.com.
Personal Brand Statement:
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Enterprise Excellence is Inclusive Excellence.pdfKaiNexus
Enterprise excellence and inclusive excellence are closely linked, and real-world challenges have shown that both are essential to the success of any organization. To achieve enterprise excellence, organizations must focus on improving their operations and processes while creating an inclusive environment that engages everyone. In this interactive session, the facilitator will highlight commonly established business practices and how they limit our ability to engage everyone every day. More importantly, though, participants will likely gain increased awareness of what we can do differently to maximize enterprise excellence through deliberate inclusion.
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2. Asset and liability management
… managing a bank's entire balance sheet
as a dynamic system of interrelated accounts
and transactions.
The phrase, asset – liability
management has generally; however,
come to refer to managing interest
rate risk
Interest rate risk
… unexpected changes in interest
rates which can significantly alter a
bank’s profitability and market value of
equity.
3. Asset and liability management
committee (ALCO)
A bank's asset and liability
management committee (ALCO)
coordinates all policy decisions and
strategies that determine a bank's risk
profit and profit objectives.
Interest rate risk management is the
primary responsibility of this
committee.
4. Net interest income or the market value of
stockholders' equity?
Banks typically focus on either:
net interest income or
the market value of stockholders' equity
as a target measure of performance.
GAP models are commonly associated with net
interest income (margin) targeting.
Earnings sensitivity analysis or net interest
income simulation, or “what if” forecasting
…provides information regarding how much NII
changes when rates are assumed to increase
or fall by various amounts.
5. Interest rate risk
Reinvestment rate risk
... the risk that a bank can not reinvest cash flows
from assets or refinance rolled over or new
liabilities at a certain rate in the future
Cost of funds versus the return on assets
⇒ Funding GAP, impact on NII
Price Risk
… changes in interest rates will also cause a
change in the value (price) of assets and liabilities
Longer maturity (duration)
⇒ larger change in value for a given change in
interest rates
⇒ Duration GAP, impact on market value of
equity
6. Interest rate risk
…the potential variability in a bank's net
interest income and market value of equity due
to changes in the level of market interest rates.
Example: $10,000 Car loan
4 year Car loan at 8.5%
1 year CD at 4.5%
Spread 4.0%
But for How long?
Funding GAP
GAP = $RSA - $RSL,
where $RSA = $ amount of assets which will
mature or reprice in a give period of time.
In this example:
GAP1y = $0.00 - $10,000 = - $10,000
This is a negative GAP.
7. Funding GAP
… focuses on managing NII in the short run.
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
8. Traditional static GAP analysis
…basic steps to 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
where t = time bucket; e.g., 0-3 months
1. Management forecasts NII given the interest rate
environment
9. Rate sensitive assets and liabilities
… those assets and liabilities
management expects to be repriced
within a fixed time interval.
They include:
maturing instruments,
floating and variable rate instruments, and
any full or partial principal payments.
A bank's GAP is defined as the difference
between a bank's rate sensitive assets and
rate sensitive liabilities.
It is a balance sheet figure measured in
dollars for U.S. banks over a specific period
of time.
10. What determines rate sensitivity?
In general, an asset or liability is normally
classified as rate-sensitive with a time
frame if:
1. It matures
2. It represents and interim, or partial, principal
payment
3. The interest rate applied to outstanding
principal changes contractually during the
interval
4. The outstanding principal can be repriced
when some base rate of index changes and
management expects the base rate / index to
change during the interval
11. Factors affecting NII.
Changes in the level of i-rates.
∆NII = (GAP) * (∆iexp.)
Note: this assumes a parallel shift in the
yield curve which rarely occurs
Changes in the slope of the yield curve
or the relationship between asset yields
and liability cost of funds
Changes in the volume of assets and
liabilities
Change in the composition of assets and
liabilities
12. Expected balance sheet for hypothetical bank
Expected Balance Sheet for Hypothetical Bank
Assets Yield Liabilities Cost
Rate sensitive 500 8.0% 600 4.0%
Fixed rate 350 11.0% 220 6.0%
Non earning 150 100
920
Equity
80
Total 1000 1000
GAP = 500 - 600 = -100
NII = (0.08 x 500 + 0.11 x 350) - (0.04 x 600 + 0.06 x 220)
NIM = 41.3 / 850 = 4.86%
NII = 78.5 - 37.2 = 41.3
13. Factors affecting net interest income
1% increase in the level of all short-term rates
1% decrease in spread between assets yields
and interest cost
RSA increase to 8.5%
RSL increase to 5.5%
Proportionate doubling in size.
Increase in RSA’s and decrease in RSL’s
RSA = 540, fixed rate = 310
RSL = 560, fixed rate = 260.
14. 1% increase in short-term rates
Expected Balance Sheet for Hypothetical Bank
Assets Yield Liabilities Cost
Rate sensitive 500 9.0% 600 5.0%
Fixed rate 350 11.0% 220 6.0%
Non earning 150 100
920
Equity
80
Total 1000 1000
GAP = 500 - 600 = -100
NII = (0.09 x 500 + 0.11 x 350) - (0.05 x 600 + 0.06 x 220)
NIM = 40.3 / 850 = 4.74%
NII = 83.5 - 43.2 = 40.3
15. Changes in NII are directly proportional to
the size of the GAP
∆NIIexp = (GAP) * (∆ iexp)
The larger is the GAP, the greater is
the dollar change in NII.
*This applies only in the case of a
parallel shift in the yield curve, which
is rare.
If rates do not change by the same
amount, then the GAP may change by
more or less.
16. 1% decrease in spread
… non- parallel shift in the yield curve
Expected Balance Sheet for Hypothetical Bank
Assets Yield Liabilities Cost
Rate sensitive 500 8.5% 600 5.5%
Fixed rate 350 11.0% 220 6.0%
Non earning 150 100
920
Equity
80
Total 1000 1000
GAP = 500 - 600 = -100
NII = (0.085 x 500 + 0.11 x 350) - (0.055 x 600 + 0.06 x 220)
NIM = 34.8 / 850 = 4.09%
NII = 81 - 46.2 = 34.8
17. Proportionate doubling in size
Expected Balance Sheet for Hypothetical Bank
Assets Yield Liabilities Cost
Rate sensitive 1000 8.0% 1200 4.0%
Fixed rate 700 11.0% 440 6.0%
Non earning 300 200
1840
Equity
160
Total 2000 2000
GAP = 1000 - 1200 = -200
NII = (0.08 x 1000 + 0.11 x 700) - (0.04 x 1200 + 0.06 x 440)
NIM = 82.6 / 1700 = 4.86%
NII = 157 - 74.4 = 82.6
18. Increase in RSAs and decrease in RSLs
RSA increase to 540, fixed rate assets to 310;
RSL decrease to 560, fixed rate liabilities to 260.
Expected Balance Sheet for Hypothetical Bank
Assets Yield Liabilities Cost
Rate sensitive 540 8.0% 560 4.0%
Fixed rate 310 11.0% 260 6.0%
Non earning 150 100
920
Equity
80
Total 1000 1000
GAP = 540 - 560 = -20
NII = (0.08 x 540 + 0.11 x 310) - (0.04 x 560 + 0.06 x 260)
NIM = 39.3 / 850 = 4.62%
NII = 77.3 - 38 = 39.3
19. Rate volume, and mix analysis
Many banks publish a summary of how
net interest income has changed over
time.
They separate changes over time to
shifts in assets and liability composition
and volume from changes associated
with movements in interest rates.
The purpose is to assess what factors
influence shifts in net interest income
over time.
20. Rate/VolumeAnalysisForSynovusBank
Yield/ Net Yield/ Net
Rate Change Rate Change
Taxable loans, net $ 149,423 -117,147 32,276 161,222 36,390 197,612
Tax-exempt loans, net
t 1,373 -586 787 1,108 -450 658
Taxable investment securities -5,313 -916 -6,229 4,507 2,570 7,077
Tax-exempt investment securities
t 2,548 74 2,622 2,026 -206 1,820
Interest earning deposits with 223 -176 47 28 48 76
Federal funds sold 406 -1,745 -1,339 1,447 1,410 2,857
Mortgage loans held for sale 7,801 -1,680 6,121 -113 549 436
Total interest income 156,461 -122,176 34,285 170,225 40,311 210,536
Interest bearing demand deposits $ 6,074 -12,517 -6,443 1,537 5,433 6,970
Money market accounts 21,380 -36,244 -14,864 4,654 13,888 18,542
Savings deposits -369 -3,307 -3,676 -660 -67 -727
Time deposits 32,015 -22,545 9,470 38,824 32,812 71,636
Federal funds purchased and -6,165 -29,744 -35,909 23,148 15,870 39,018
Other borrowed funds 21,318 -4,272 17,046 21,960 3,361 25,321
Total interest expense 74,253 -108,629 -34,376 89,463 71,297 160,760
Net interest income $82,208 ($13,547) $68,661 $80,762 ($30,986) $49,776
Interest earned on:
Interest paid on:
Volume Volume
2001 Compared to 2000 2000 Compared to 1999
Change Due to * Change Due to *
21. Rate sensitivity reports
…classifies a bank’s assets and liabilities
into time intervals according to the
minimum number of days until each
instrument can be repriced.
A rate sensitivity report shows GAP values
on a periodic and cumulative basis for each
time interval.
Periodic GAP
… measures the timing of potential income
effects from interest rate changes
Gap for each time bucket
Cumulative GAP
… measures aggregate interest rate risk over
the entire period
Sum of periodic GAP's
22. Rate sensitivity analysis for security bank
MM Inv 1.2 1.8 3.0
Municipals 0.7 1.0 2.2 7.6 11.5
FF & Repo's 5.0 5.0
Comm loans 1.0 13.8 2.9 4.7 4.6 15.5 42.5
Install loans 0.3 0.5 1.6 1.3 1.9 8.2 13.8
Cash 9.0 9.0
Other assets 5.7 5.7
Total Assets 6.3 15.0 10.0 10.0 9.0 35.0 14.7 100.0
Liabilities and Equity
MMDA 5.0 12.3 17.3
Super NOW 2.2 2.2
CD's < 100,000 0.9 2.0 5.1 6.9 1.8 2.9 19.6
CD's > 100,000 1.9 4.0 12.9 7.9 1.2 27.9
FF purchased -
NOW 9.6 9.6
Savings 1.9 1.9
DD 13.5 13.5
Other liabilities 1.0 1.0
Equity 7.0 7.0
Total Liab & Eq. 5.0 11.0 30.3 24.4 3.0 4.8 21.5 100.0
GAP
Periodic GAP 1.3 4.0 -20.3 -14.4 6.0 30.2
Cumulative GAP 1.3 5.3 -15.0 -29.4 -23.4 6.8
23. Positive and negative gap’s
Positive GAP
…indicates a bank has more rate sensitive
assets than liabilities, and that net interest
income will generally rise (fall) when
interest rates rise (fall).
Negative GAP
…indicates a bank has more rate sensitive
liabilities than rate sensitive assets, and that
net interest income will generally fall (rise)
when interest rates rise (fall).
24. Optimal value for a bank’s GAP?
There is no general optimal value for a bank's
GAP in all environments.
GAP is a measure of interest rate risk.
The best GAP for a bank can be determined
only by evaluating a bank's overall risk and
return profile and objectives.
Generally, the farther a bank's GAP is from
zero, the greater is the bank's risk.
Many banks establish GAP policy targets to
control interest rate risk by specifying that
GAP as a fraction of earning assets should be
plus or minus 15%, or the ratio of RSAs to
RSLs should fall between 0.9 and 1.1.
25. Speculating on the GAP.
∆NII = (GAP) * (∆ iexp)
Many bank managers attempt to adjust the
interest rate risk exposure of a bank in
anticipation of changes in interest rates.
This activity is speculative because it assumes
that management can forecast rates better than
forward rates embedded in the yield curve.
Speculating on the GAP
Difficult to vary the GAP and win – requires
accurate interest rate forecast on a consistent
basis.
Usually only look short term.
Only limited flexibility in adjusting the GAP,
customers and depositors.
No adjustment for timing of cash flows or
dynamics of the changing GAP position.
26. Advantages / disadvantages of GAP
The primary advantage of GAP analysis
is its simplicity.
The primary weakness is that it ignores
the time value of money.
GAP further ignores the impact of
embedded options.
For this reason, most banks conduct
earnings sensitivity analysis, or pro
forma analysis, to project earnings and
the variation in earnings under different
interest rate environments.
27. Link between GAP and net interest margin
Some ALM programs focus on the
GAP or GAP ratio when evaluating
interest rate risk:
GAP Ratio = RSAs / RSLs
When the GAP is positive, the GAP
ratio is greater than one.
A negative GAP, in turn, is consistent
with a GAP ratio less than one.
28. GAP and potential variability in earnings
Neither the GAP nor GAP ratio provide direct
information on the potential variability in
earnings when rates change.
The GAP ratio ignores size.
Example: Consider two banks that have $500
million in total assets.
The first bank has $3 million in RSAs and $2
million in RSLs, its GAP = $1 million and its GAP
ratio = 1.5 million.
The second bank has $300 million in RSAs and
$200 million in RSLs.
Its GAP equals $100 million, yet it reports the
same 1.5 GAP ratio.
Clearly, the second bank assumes greater interest
rate risk because its net interest income will
change more when interest rates change.
29. ratesinterestinchange%Expected
NIM)tedNIM)(Expecinchange%(Allowable
assetsEarning
GAPTarget
=
Target NIM and GAP
A better risk measure relates the absolute value
of a bank’s GAP to earning assets.
The greater is this ratio, the greater the interest
rate risk
The ratio of GAP to earning assets has the
additional advantage in that it can be directly
linked to variations in NIM.
In particular, management can determine a
target value for GAP in light of specific risk
objectives stated terms of a bank’s target NIM:
30. Example:
Consider a bank with $50 million in earning assets that
expects to generate a 5% NIM. The bank will risk changes
in NIM equal to plus or minus 20% during the year, NIM
should fall between 4 and 6%.
Management expects interest rates to vary up
to 4 percent during the upcoming year
The bank’s ratio of its 1-year cumulative GAP
(absolute value) to earning assets should not
exceed 25 percent.
Target GAP/Earning assets (.20)(0.05) / 0.04 = 0.25
Management’s willingness to allow only a 20
percent variation in NIM sets limits on the GAP
which would be allowed to vary from $12.5
million to $12.5 million, based on $50 million in
earning assets.
31. Earnings sensitivity analysis
…allows management to incorporate the
impact of different spreads between asset
yields and liability interest costs when rates
change by different amounts.
Shifts in the yield curve are rarely
parallel!
It is well recognized that banks are
quick to increase base loan rates but
are slow to lower base loan rates when
rates fall.
32. Exercise of embedded options in
assets and liabilities
Customers have different types of
options, both explicit and implicit:
Option to refinance a loan
Call option on a federal agency bond
the bank owns
Depositors option to withdraw funds
prior to maturity
33. Interest rate risk and embedded options
…our previous example
Example: $10,000 Car loan
4 year Car loan at 8.5%
1 year CD at 4.5%
Spread 4.0%
But for How long?
Funding GAP
GAP = $RSA - $RSL,
where $RSA = $ amount of assets which will
mature or reprice in a give period of time.
In this example:
GAP1y = $0.00 - $10,000 = - $10,000
This is a negative GAP.
34. Implied options:
10,000 4yr loan, financed by a 1 yr CD
In the previous example, what if rates increased?
-3 -2 -1 base +1 +2 +3
-1,000 -2,000 -8,000 -10,000
Gap
-10,000 -10,000 -10,000
Re-finance the auto loans All CD’s will mature
3 month GAP is zero by definition:
-3 -2 -1 base +1 +2 +3
+8,000 +6,000 +2,000 0
Gap
-1,000 -3,000 -6,000
Re-finance the auto loans,
and less likely to “pull” CD’s
People will “pull” the CD’s
for higher returns
1 year GAP position:
35. The implications of embedded options
Is the bank the buyer or seller of the option
Does the bank or the customer determine when
the option is exercised?
How and by what amount is the bank being
compensated for selling the option, or how
much must it pay to buy the option?
When will the option be exercised?
Often determined by the economic and interest
rate environment
Static GAP analysis ignores these embedded
options
36. Earnings sensitivity analysis consists
of six general steps:
1. Forecast future interest rates,
2. Identify changes in the composition of assets
and liabilities in different rate environments,
3. Forecast when embedded options will be
exercised,
4. Identify when specific assets and liabilities
will reprice given the rate environment,
5. Estimate net interest income and net income,
and
6. Repeat the process to compare forecasts of
net interest income and net income across
rate environments.
37. Earnings sensitivity analysis
ABC rate-sensitivity report for most likely (base case)
Assets
3 Months >3-6 >6-12 >1-3 >3-5 >5-10 >10-20 >20
Total or Less Months Months Years Years Years Years Years
Loans
Prime Based 100,000 100,000
Equity Credit Lines 25,000 25,000
Fixed Rate >1 yr 170,000 18,000 18,000 36,000 96,000 2,000
Var Rate Mtg I Yr 55,000 13,750 13,750 27,500
30-Yr Fix Mortgage 250,000 5,127 5,129 9,329 32,792 28,916 116,789 51,918
Consumer 100,000 6,000 6,000 12,000 48,000 28,000
Credit Card 25,000 3,000 3,000 6,000 13,000
Investments
Eurodollars 80,000 80,000
CMOs FixRate 35,000 2,871 2,872 5,224 13,790 5,284 4,959
US Treasury 75,000 5,000 5,000 25,000 40,000
Fed Funds Sold 25,000 25,000
Cash & Due From Banks 15,000 15,000
Loan Loss Reserve -15,000 -15,000
Non-earning Assets 60,000 60,000
Total Assets 1,000,000 278,748 53,751 101,053 228,582 104,200 121,748 51,918 60,000
38. 3 Months >3-6 >6-12 >1-3 >3-5 >5-10 >10-20 >20
Total or Less Months Months Years Years Years Years Years
Deposits
MMDAs 240,000 240,000
Retail CDs 400,000 60,000 60,000 90,000 160,000 30,000
Savings 35,000 35,000
NOW 40,000 40,000
DDA Personal 55,000 55,000
Comm'l DDA 60,000 24,000 36,000
Borrowings
TT&L 25,000 25,000
L-T notes FR 50,000 50,000
Fed Funds Purch 0
NIR Liabilities 30,000 30,000
Capital 65,000 65,000
Tot Liab & Equity 1,000,000 349,000 60,000 90,000 160,000 30,000 50,000 0 261,000
Swaps- Pay Fixed 50,000 -25,000 -25,000
GAP -20,252 -6,249 11,053 43,582 49,200 71,748 51,918 -201,000
CUMULATIVE GAP -20,252 -26,501 -15,448 28,134 77,334 149,082 201,000 0
Earnings sensitivity analysis
ABC rate-sensitivity report for most likely (base case)
Liabilities and GAP measures
39. Fed Funds Forecast vs. Implied Forward Rates
Time (month)FedFundsRate%
6.50
6.25
6.00
5.75
5.50
5.25
5.00
1 3 5 7 9 11 13
Market Implied Rates
Most Likely Forecast
15 17 19 21 23
Interest Rate
Forecasts
Most LikelyForecast andRate RampsDec. 2001
P
e
rc
e
n
t
10
8
6
4
2
0
11 1
2002
3 5 7 9 11 1
2003
3 5 7 9 12
40. 2
(.5)
1.0
.5
ALCO Guideline
Board Limit
(1.0)
(1.5)
ChangeinNII($MM)
(2.0)
(2.5)
(3.0)
-300 -200 -100 +100 +200 +300ML
Ramped Change in Rates from Most Likely (Basis Points)
Sensitivity of Earnings: Year Two
1.0
.5
2
ALCO Guideline
Board Limit
(1.0)
(.5)
(1.5)ChangeinNII($MM)
(2.0)
(2.5)
(3.0)
(3.5)
-300 -200 -100 +100 +200 +300ML
Ramped Change in Rates from Most Likely (Basis Point)
Sensitivity of Earnings: Year OneEarningssensitivityoveroneandtwo
yearsversusmostlikelyratescenario
41. Earnings at risk
…the potential variation in net interest income across
different interest rate environments, given different
assumptions about balance sheet composition, when
embedded options will be exercised, and the timing of
repricings.
Demonstrates the potential volatility in
earnings across these environments.
The greater is the potential variation in
earnings (earnings at risk), the greater
is the amount of risk assumed by a
bank.
42. Earnings-at-risk for PNC and Washington
Mutual for a gradual change in interest
rates, December 31, 2001
PNC -2% -1% 1% 2%
Net interest income change -2.80% -0.30%
for next 1 year (2002)
Washington Mutual
Net interest income change 1.47% -5.18%
for next 1 year (2002)
Net income change for 2.19% -2.76%
next 1 year (2002)
Gradual Change in Interest Rates*
43. Income statement gap
For smaller banks with limited off-balance
sheet exposure, one procedure is to use
Income Statement GAP analysis, which is a
simplified procedure that takes some of the
factors into account.
This model uses an all encompassing Earnings
Change Ratio (ECR).
This ratio attempts to incorporate information
on each asset and liability.
This ratio indicates how the yield on each asset,
and rate paid on each liability, is assumed to
change relative to a 1 percent drop in the prime
rate.
44. Balance Income Balance Income
Sheet Statement Sheet Statement
GAP* GAP GAP* GAP
A B A X B C D C x D
Fixed Rate $5,661 100% $5,661 $5,661 100% $5,661
Floating Rate 3,678 100% 3,678 3,678 100% 3,678
Principal Cash Flows
Agencies 200 71% 142 200 71% 142
Agy Callables 2,940 71% 2,087 300 60% 180
CMO Fixed 315 58% 183 41 51% 21
Fed Funds Sold 2,700 96% 2,592 2,700 96% 2,592
Floating Rate
$15,494 $14,343 $12,580 $12,274
Savings $1,925 75% $1,444 $1,925 5% $96
Money Mkt Accts 11,001 60% 6,601 11,001 40% 4,400
NOW 2,196 80% 1,757 2,196 20% 439
Fed Funds Purch/Repo 0 96% 0 0 96% 0
CDs - IOOM 3,468 85% 2,948 3,468 85% 2,948
CDs < 100M 4,370 84% 3,671 4,370 84% 3,671
$22,960 $16,420 $22,960 $11,554
($7,466) ($2,077) ($10,380) $719
$29,909 $29,909 $29,909 $29,909
-24.96% -6.94% -34.71% 2.41%
($20.8) $7.2
0.07% 0.02%
5.20% 5.20%
1.34% 0.46%
Amounts In Thousands Prime Down 100bp Prime Up 100bp
Report data as of 09-30-02
ECR
t
ECR
t
Rate-Sensitive Assets
Loans
Securities
Total Rate-Sensitive Assets
Rate-Sensitive Liabilities
Total Rate-Sensitive
LiabilitiesRate Sensitivity Gap (Assets-
Liab)Total Assets
Percentage Change in Net
GAP as a Percent of Total
AssetsChange in Net Interest
Change in Net Interest
Net Interest Margin
IncomestatementGAPandearningsvariability
45. Steps that banks can take to reduce
interest rate risk
Calculate periodic GAPs over short
time intervals.
Match fund repriceable assets with
similar repriceable liabilities so that
periodic GAPs approach zero.
Match fund long-term assets with
noninterest-bearing liabilities.
Use off-balance sheet transactions,
such as interest rate swaps and
financial futures, to hedge.
46. Various ways to adjust the effective rate sensitivity
of a bank’s assets and liabilities on-balance sheet.
Objective Approaches
Reduce asset
sensitivity
Buy longer-term securities.
Lengthen the maturities of loans.
Move from floating-rate loans to term loans.
Increase asset
sensitivity
Buy short-term securities.
Shorten loan maturities.
Make more loans on a floating-rate basis.
Reduce liability
sensitivity
Pay premiums to attract longer-term deposit
instruments.
Issue long-term subordinated debt.
Increase liability
sensitivity
Pay premiums to attract short-term deposit
instruments.
Borrow more via non-core purchased liabilities.