Question

Rate-Sensitive Bank Assets Liabilities $5 Variable-rate Loans Short-term Loans Short-term Securities Reserves Variable-rate CDs Money Market Deposit Accounts Checkable Deposits Savings Deposits Long-term CDs Equity Capital Long-term Loans Long-term Securities 30 30 Referring to the table above, and using basic gap analysis, this bank's "gap" is $ million. (Round your response to the nearest whole number.) Referring to the table above, if interest rates suddenly increase by two percentage points, then the bank's profits change by $ whole number.) (Round your response to the nearest . (Round your response to Referring to the table above, if, instead, interest rates suddenly decrease by three percentage points, then the bank's profits change by $ the nearest whole number.)

Answer 1

Basic Gap Analysis technique is the technique used for assets liability management used to assess interest rate/liquidity risk. Under this technique, interest rate sensitive liabilities are reduced from the corresponding interest rate sensitive assets to get the gap. This gap is multiplied by the percent change in interest rate to get an approximate change in the net interest income of the entity. A negative gap discloses that liabilities exceed assets and an increase in the market interest rate would result in a decline in the net interest income of the entity and vice versa.
1. Calculation of the Bank's Gap, using the basic gap analysis.
Bank's Gap = Rate Sensitive Assets minus Rate Sensitive Liabilities
Bank's Gap = $ 30 million - $ 50 million    *
Bank's Gap = $ 20 million         RSL>RSA
*Working:
Rate Sensitive Assets:
Particulars	Amount ($ in millions)
Variable Rate Loans	$5
Short Term Loans	$10
Short Term Securities	$15
Rate Sensitive Assets	$30
Rate Sensitive Liabilities:
Particulars	Amount ($ in millions)
Variable Rate CDs	$30
Money Market Deposits Accounts	$20
Rate Sensitive Liabilities	$50
2. Change in Bank's Profit, on an increase in interest rates by 2% points.
Change in Bank Profits = Bank's Gap * Change in Interest Rate
Change in Bank Profits = $ 20 million * 2%
Change in Bank Profits = $ 4 million
Since there was a negative gap, i.e. liabilities exceeded assets by $ 20 million, therefore the increase in the interest rate would result in a decline in the net interest income of the entity by $ 4 million.
3. Change in Bank's Profit, on a decrease in interest rates by 3% points.
Change in Bank Profits = Bank's Gap * Change in Interest Rate
Change in Bank Profits = $ 20 million * 3%
Change in Bank Profits = $ 6 million
Since there was a negative gap, i.e. liabilities exceeded assets by $ 20 million, therefore the decrease in the interest rate would result in an increase in the net interest income of the entity by $ 6 million.