In many countries banks are required to disclose their period-end interest rate gap positions in the form of the following report. These reports show balance sheet assets and liabilities broken down by when they are next due for repricing. The effects of off-balance sheet items such as swaps are also included within the summary.
A positive interest rate gap means that more assets than liabilities are due to be repriced in a particular time interval. The following bank has a negative yield gap over the next 12 months and as such net interest margins should benefit from falling interest rates.
This would suggest that we can quantify the impact of rate changes within a specific time interval. The impact of an increase in short-term rates for a specific interval is given in general by:
Impact on net interest income = Balance sheet gap for time interval × àr For the three-month or less time interval for a 100 bpt increase in rates would imply:
Impact on net interest income = ?($7500m × 0.01) = ?$75m
Concentrating on managing short-term interest rate gaps can help banks report relatively stable spreads but this may have the effect of ignoring duration gaps for assets and liabilities with long duration. This will lead to increased risks of losses in economic value.
In practice analysts do not find gap reports of much use for a number of reasons:
They represent a snapshot in time and by the time they are released are usually well out of date. They indicate how a bank was positioning itself for changing interest rates rather than what they are now expecting. The use of the off-balance sheet instruments allows banks to adjust their gap positions in the medium and long term relatively quickly. They do not take any account of embedded options whether explicit as with mortgage pre- payments, or implicit options that exist in many deposits. If interest rates rise some demand deposit holders will exercise their option to withdraw their funds and redeposit them in an interest-bearing account. The time intervals are generally very broad and banks do not report an average repricing period. An analyst usually makes simplifying assumptions, for example that all deposits in the three to six-month time frame are repriced after four and a half months. Interest rates can remain stable for a protracted period but at times may change on a regular basis over a period of many months. It becomes increasingly difficult to estimate the potential impact of multiple interest rate changes on repricing. Rates across the yield curve do not usually change in parallel.
Banks are not passive observers. When interest rates are falling they will try to cut borrowing rates more than they cut lending rates. Lending rates are generally relatively sticky in a falling interest rate environment.