Maturity Gap

What Is a Maturity Gap?

A maturity gap is the difference between the total market values of interest rate sensitive assets versus interest rate sensitive liabilities that will mature or be repriced over a given scope of future dates. It gives a measure of the interest rate based repricing risk that a bank faces for a given set of assets and liabilities of comparative maturity dates and the likely impact of changing interest rates on net interest income. In effect, in the event that interest rates change, interest income and interest expense will change as the various assets and liabilities are repriced.

Understanding the Maturity Gap

A bank is uncovered to liquidity risk, that is, the risk that it will have inadequate cash to meet its funding requirements. To guarantee that it has an adequate level of cash for its tasks; the terms of maturity of its assets and liabilities must be observed. If the gap between the values of developing assets and liabilities held is extremely large, the bank might be forced to look for somewhat costly "money at call" borrowings.

Before investigating maturity gap analysis, we must initially audit how banks operate, which is marginally not the same as most corporations. Assets for banks incorporate loans, which is outlandish since we think of loans as debt. Nonetheless, for a bank, a loan is a flood of income as the principal and interest payments from the borrower. Liabilities, then again, incorporate deposits, which again for an individual investor would be an asset. Notwithstanding, banks pay investors interest on those funds, which is viewed as an expense. Of course, deposits are important on the grounds that those funds are utilized to make loans to the bank's customers.

Thus, on the off chance that interest rates rise, banks could earn additional income from their loans, yet they likewise need to pay a higher rate to contributors. Maturity gap analysis helps address the difference between the money due to contributors and the income expected from loans throughout various time periods.

Maturity Gap Analysis

The maturity date of every asset or liability characterizes an interval or band of dates that must be assessed. The interval is a scope of future dates, for instance 30-90 days from now. The maturity gap for this interval can be found by adding up the values of all assets and liabilities that will either arrive at their maturity and should be renegotiated or turned over (for fixed rates) or be repriced (for floating rates).

To comprehend the gap, assets and liabilities are assembled by their maturity or repricing intervals. For instance, assets and liabilities due to mature in under 30 days are gathered, assets and liabilities with a maturity date somewhere in the range of 270 and 365 days are remembered for a similar category, etc. Longer repricing periods have a higher sensitivity to interest rate changes and are subject to any change over the interceding year. An asset or a liability with an interest rate that can't change for over a year is viewed as fixed.

The maturity gap analysis compares the value of assets that either mature or are repriced inside a given time interval to the value of liabilities that either mature or are repriced during a similar time span. Reprice means there's the possibility to receive another interest rate.

A positive maturity gap demonstrates that the bank holds more rate sensitive assets that rate sensitive liabilities for that interval. A negative maturity gap shows that the bank holds more interest rate sensitive liabilities that will be due during that interval. The size of the gap between the assets and liabilities addresses the degree of likely risk or volatility of the value of the holdings if market interest rates change among from time to time.

Illustration of Maturity Gap Analysis

For instance, the balance sheet for a bank is given in the table below. We should work out the maturity gap and net interest income (or expense) for next year assuming interest rates increase by 2% (or 200 basis points).

Interest Rate Sensitive Assets - Interest Rate Sensitive Liabilities

= $10 - $12

= -$2 million

Since the bank has more interest rate sensitive liabilities than assets in this band, the maturity gap is negative. This means that a rise in interest rates is expected to lead to a lessening in net interest income over this period.

Expected net interest income (in millions) toward the year's end is:

Interest income from Assets - Interest expense from Liabilities

= ($10 x 8%) + ($15 x 6%) - [($12 x 5%) + ($8 x 5%)]

= $0.80 + $0.90 - ($0.60 + $0.40)

= $1.7 - $1

Expected Net Interest Income = $0.70, or $700,000

Maturity Gap After Change in Interest Rates

Assuming that interest rates increase, we should perceive what the change will mean for the organization's expected net interest income utilizing maturity gap analysis. Duplicate the market values by the change in interest (2%), remembering that the rate-sensitive or floating assets and liabilities will be impacted by the change in rates.

Assets:

• Assets - Floating rate loans: $10 x (8% + 2%) = $1
• Fixed rate loans: $15 x 6% = $0.90 (no change in rates)

Liabilities:

• Liabilities - Current deposits: $12 x (5% + 2%) = $0.84
• Fixed term deposits: $8 x 5% = $0.40 (no change in rates)

Work out the net interest income by adding the resultant values together.

• Net Interest Income = $1 + $0.90 + (- $0.84) + (- $0.40)
• Net Interest Income = $0.66, or $660,000

In the event that interest rates increase by 2%, the expected net interest income will diminish by $40,000 or ($700,000 - $660,000). Albeit a bank normally earns additional income from loans with an increase in overall interest rates, the bank, in our model, saw its net interest income decline. The justification for the decline was that the bank had a larger amount of non-fixed rate deposits ($12 million) than variable-rate loans ($10 million). All in all, the cost of deposits rose by more than the increase in income from variable-rate loans.

On the other hand, assuming interest rates declined by 2% all things being equal, the net interest income will increase by $40,000 to $740,000. The justification behind the rise in income-regardless of lower rates-is due to the bank having more fixed-rate loans ($15 million) than variable-rate deposits ($10 million). In the subsequent scenario, the fixed-rate loans assisted the bank with earning a consistent interest income notwithstanding a lower rate environment.

The maturity gap method, while helpful, isn't generally so famous as it used to be due to the rise of new procedures in recent years. More up to date procedures like asset/liability duration and value at risk (VaR) have largely supplanted maturity gap analysis.

Features

• Maturity gap is a measurement of interest rate risk for rate sensitive assets and liabilities.
• The maturity gap model assists with estimating the possible changes in net interest income from changes in overall interest rates.
• In the event that interest rates change, interest income and interest expense will change as the various assets and liabilities will be repriced.