Managing Interest Rate
Risk: GAP and Earnings
Sensitivity
11

Managing Interest Rate Risk
n
Interest Rate Risk
n
The potential loss from unexpected
changes in interest rates which can
significantly alter a bank’s profitability
and market value of equity
22

Managing Interest Rate Risk
n
Interest Rate Risk
n
When a bank’s assets and liabilities do
not reprice at the same time, the result
is a change in net interest income
n
The change in the value of assets and
the change in the value of liabilities will
also differ, causing a change in the
value of stockholder’s equity
33

Managing Interest Rate Risk
n
Interest Rate Risk
n
Banks typically focus on either:
n
Net interest income or
n
The market value of stockholders'
equity
n
GAP Analysis
n
A static measure of risk that is
commonly associated with net interest
income (margin) targeting
n
Earnings Sensitivity Analysis
n
Earnings sensitivity analysis extends
44

Managing Interest Rate Risk
n
Interest Rate Risk
n
Asset and Liability Management
Committee (ALCO)
n
The bank’s ALCO primary
responsibility is interest rate risk
management.
n
The ALCO coordinates the bank’s
strategies to achieve the optimal
risk/reward trade-off
55

Measuring Interest Rate Risk with
GAP
n
Three general factors potentially
cause a bank’s net interest income to
change.
n
Rate Effects
n
Unexpected changes in interest rates
n
Composition (Mix) Effects
n
Changes in the mix, or composition, of
assets and/or liabilities
n
Volume Effects
n
Changes in the volume of earning
assets and interest-bearing liabilities
66

Measuring Interest Rate Risk with
GAP
n
Consider a bank that makes a $25,000
five-year car loan to a customer at
fixed rate of 8.5%.
The bank initially
funds the car loan with a one-year
$25,000 CD at a cost of 4.5%.
The
bank’s initial spread is 4%.
n
What is the bank’s risk?
77

Measuring Interest Rate Risk with
GAP
n
Traditional Static Gap Analysis
n
Static GAP Analysis
GAPt = RSAt - RSLt
n
RSAt
§
Rate Sensitive Assets
§
Those assets that will mature or reprice
in a given time period (t)
n
RSLt
§
Rate Sensitive Liabilities
§
Those liabilities that will mature or
reprice in a given time period (t)
88

Measuring Interest Rate Risk with
GAP
n
Traditional Static Gap Analysis
n
Steps in GAP Analysis
1.
Develop an interest rate forecast
2.
Select a series of “time buckets” or
time intervals for determining when
assets and liabilities will reprice
3.
Group assets and liabilities into these
“buckets”
4.
Calculate the GAP for each “bucket ”
5.
Forecast the change in net interest
income given an assumed change in
99

Measuring Interest Rate Risk with
GAP
n
What Determines Rate Sensitivity
n
The initial issue is to determine what
features make an asset or liability rate
sensitive
1010

Measuring Interest Rate Risk with
GAP
n
Expected Repricing versus Actual
Repricing
n
In general, an asset or liability is
normally classified as rate sensitive
within a time interval if:
§
It matures
§
It represents an interim or partial principal
payment
§

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- Fall '08
- cobus
- Balance Sheet, Interest Rates, Interest, Interest Rate, rate risk, net interest income