Static Gap

What Is Static Gap?

Static gap is a measure of exposure or sensitivity to interest rates, calculated as the difference among assets and liabilities of comparable repricing periods.

• Static gap measures the exposure or sensitivity to interest rates. It is the difference among assets and liabilities of comparable repricing periods.
• It tends to be calculated for short-term, long-term, and various time spans and is for the most part utilized for time periods of under a year.
• The static gap is commonly employed by banks: A bank gets funds at one rate and loans the money out at a higher rate, with the gap addressing its profit.
• Static gap analysis fails to account for some factors, including interim cash flow, average maturity, and prepayment of the loan.

How Static Gap Works

Static gap is a measure of the gap between assets (money held) and liabilities (money loaned out or sensitive to interest) at a set moment in time. Minus signs, or a negative value, in the calculated gap demonstrate a greater number of liabilities than assets maturing at that specific maturity.

This type of analysis is commonly utilized in the banking industry. A bank gets funds at one rate and loans the money out at a higher rate, with the gap, or difference, between the two addressing its profit.

Static gap can be calculated for short-term, long-term, and various time spans. Generally, it is calculated for time periods of under a year — frequently 0 to 30 days or 31 to 90 days.

Illustration of Static Gap

Assume a bank has both $5 million in assets and $5 million in liabilities that reprice in some random time window. Changes in interest rates shouldn't change the bank's net interest margin (NIM) — the interest it earns compared to the amount of interest paid out to its lenders. This scenario would address a balanced gap position.

If all things being equal, $12 million in assets reprice with just $6 million in liabilities repricing, the bank will end up in an asset sensitive position. In this case, an asset sensitive bank will benefit from a NIM increment in the event that interest rates rise.

Conversely, if by some stroke of good luck $5 million in assets reprice during the very period that $8 million in liabilities reprice, it is known as a liability sensitive position. Here, assuming interest rates rise, NIM will decline. Essentially, in the event that interest rates fall the liability-sensitive bank will project a more extensive NIM.

Limitations of Static Gap

A negative gap doesn't be guaranteed to continuously spell terrible news for financial institutions (FIs). Indeed, when interest rates fall banks earn less from interest-sensitive assets. Be that as it may, they additionally pay less on their interest-related liabilities.

In reality, banks that have a higher level of liabilities than assets are the ones that see all the more a burden on their bottom line from a negative gap.

Important

Simple static gaps are not generally exact and dependable, specifically on the grounds that they fail to consider several important factors that can have a big bearing on interest rate exposure.

There's additionally the static gap's oversights to think about. Simple static gaps are intrinsically loose measurements since they don't consider factors, for example, interim cash flow, average maturity, and prepayment of the loan.

A common, and glaring, hole in gap analysis is its failure to account for the flexibility embedded in numerous assets and liabilities. In the event that rates drop and assets prepay surprisingly quick, or on the other hand assuming rates rise and the average life of assets is unexpectedly extended, these possibilities are commonly not a part of simple static gap reporting and analysis.

Different issues arise for non-maturity deposits. Certain deposits are carried in perpetuity, paying for a limitless amount of time.

Static Gap versus Dynamic Gap

Static gap analysis centers around the difference among assets and liabilities at one moment in time. Dynamic gap, then again, endeavors to measure the gap over the long haul and financial obligations change.

Instead of taking a snapshot, this alternative method endeavors to follow the consistent extending and contracting gap as bank accounts are opened and closed and loans offered to customers and owed to other FIs are approved and paid back.