Interest Rate Gap
Overview
Interest rate gap analysis tries to create a report which gives an indication of when the banks assets reprice
versus when its liabilities reprice. That is, an asset reprices when the interest rate that it pays is reset.
For example, a variable rate loan where the variable rate is reset quarterly is said to reprice quarterly.
Assets that mature are considered to reprice at maturity. (The principal is paid and re-invested in a new loan or security
and receives the rate of the new asset).
Measurement
- Break the future into a set of time buckets. For example, now to three months, three months to a year, 1 year to 5 years etc..
- Sum all the assets that reprice in each bucket, and sum the dollar value of all liabilities for each bucket
- The Gap for each bucket is the difference between the assets that reprice and the liabilities that reprice.
The assets and liabilities that are included in the analysis are the ones that considered to be a
fixed income instrument
of one sort or another. (That is, the bank will typically not include any buildings that it owns, or other such assets)
Typically these assets are referred to as Rate Sensitive Assets (RSAs) or
Rate Sensitive Liabilities (RSLs).
Re-Pricing Criteria
After splitting the future time frame into buckets, one groups bank assets by repricing date. Typically this just means to
select assets that have a contractual rate that reprices during the given bucket, or the asset matures and pays off its principal.
However, there are complications.
- Some assets have optionality,
meaning that the holder of the asset can choose whether
to reprice the asset. (as in pre-payments for example)
One way to address this issue is to include an interest rate forcast in the gap analysis and then to include assets as
belonging to a bucket when it is likely that the holder of the asset would exercise the option in the given forecasted
rate environment.
- Some assets are
amortized,
meaning that they pay the principal off over the life of the loan,
and not just at maturity. Each principal payment represents a re-pricing of the amount of principal
paid. In these cases, one may want to include each principal payment as a repricing in the relevant period.
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