Negative Gap

What Is a Negative Gap?

A negative gap is a situation where a financial organization's interest-sensitive liabilities surpass its interest-sensitive assets. A negative gap isn't really something terrible, since, in such a case that interest rates decline, the substance's liabilities are repriced at lower interest rates. In this scenario, income would increase. Nonetheless, assuming interest rates increase, liabilities would be repriced at higher interest rates, and income would diminish.

Something contrary to a negative gap is a positive gap, where a substance's interest-sensitive assets surpass its interest-sensitive liabilities. The terms of negative and positive gaps, which investigate interest rate gaps, are otherwise called duration gap.

Grasping a Negative Gap

Negative gap is connected with gap analysis, which can assist with deciding a financial foundation's interest-rate risk as it connects with repricing, for example the change in interest rates when an interest-sensitive investment develops.

The size of an element's gap shows the amount of an impact interest rate changes will have on a bank's net interest income. Net interest income is the difference between an element's income, which it generates from its assets, including individual and commercial loans, mortgages and securities, and its expenses (e.g., interest paid out on deposits).

Negative Gap and Asset-Liability Management

A negative gap isn't really either fortunate or unfortunate, yet it is a measure of how much a bank is presented to interest-rate risk. Understanding this measurement is a part of asset-liability management, which banks must think about in their operations.

Gap analysis, as a method of asset-liability management, can be useful in evaluating liquidity risk. As a general rule, the concept of asset-liability management centers around the timing of cash flows. It sees when cash inflows are received versus when payments on liabilities are due and when the liabilities present a risk. It plans to guarantee that the timing of liability payments will constantly be covered with cash inflows from the assets.

Asset-liability management is likewise worried about the availability of assets to pay the liabilities, and when the assets or earnings might be changed over into cash. This cycle can be applied to a scope of categories of balance sheet assets.

At the point when the duration gap is zero, significance there is no positive gap or negative gap, a firm's equity is believed to be protected against interest-rate risk in light of the fact that any increases or diminishes in interest rates won't influence the firm. Nonetheless, achieving a zero gap is troublesome as not all assets and liabilities have matching durations, customer prepayments and defaults will influence the timing of cash flows, and a few assets and liabilities will have cash flow designs that are not reliable.

Features

• A negative gap is a part of asset-liability management; overseeing cash inflows to pay for liabilities.
• Assuming interest rates decline, the liabilities are priced at lower rates, expanding income. In the event that interest rates increase, the inverse is true.
• The size of a financial foundation's gap is an indicator of the impact interest rate changes will have on its net interest income.
• A zero duration gap is when there is no positive gap or negative gap and a firm is protected against interest rate developments.
• A negative gap is the point at which an element's interest-sensitive liabilities surpass its interest-sensitive assets.