Maturity Gap What it is How it Works Example

Maturity Gap: What it is, How it Works, Example

What Is a Maturity Gap?

A maturity gap is the difference between the total market values of interest rate sensitive assets versus liabilities that will mature or be repriced over a given range of future dates. It measures the interest rate based repricing risk that a bank faces and the potential impact of changing interest rates on net interest income. If interest rates change, interest income and expense will change as assets and liabilities are repriced.

Key Takeaways

– Maturity gap measures interest rate risk for assets and liabilities.

– Changes in interest rates will impact interest income and expense through repricing.

– The maturity gap model helps measure potential changes in net interest income.

Understanding the Maturity Gap

A bank faces liquidity risk, meaning it must ensure it has enough cash to meet funding requirements. To maintain adequate cash levels for operations, the bank monitors the maturity terms of its assets and liabilities. If the gap between maturing assets and liabilities is significant, the bank may need to seek expensive "money at call" borrowings.

Before delving into maturity gap analysis, it’s important to understand how banks operate differently from other corporations. For banks, loans are considered assets as they generate income through principal and interest payments. Conversely, deposits are considered liabilities as banks must pay interest on those funds. Deposits are vital as they fund loans granted to customers.

If interest rates rise, banks may earn more income from loans but must also pay higher rates to depositors. Maturity gap analysis addresses the difference between money owed to depositors and expected income from loans over different time frames.

Maturity Gap Analysis

Each asset or liability’s maturity date defines a range of future dates that must be assessed. Assets and liabilities that will mature, be refinanced, or be repriced (for fixed or floating rates) within a given interval are summed to find the maturity gap.

To understand the gap, assets and liabilities are grouped by maturity or repricing intervals. These intervals range from less than 30 days to more than a year. Longer repricing periods are more sensitive to interest rate changes and subject to any changes over the intervening year. Assets or liabilities with fixed interest rates for over a year are considered fixed.

Maturity gap analysis compares the value of assets and liabilities maturing or repricing within a specific time interval. A positive maturity gap indicates an excess of rate-sensitive assets over liabilities, while a negative gap indicates more rate-sensitive liabilities. The size of the gap reflects the potential risk or volatility of holdings due to market interest rate changes.

Example of Maturity Gap Analysis

Consider the balance sheet of a bank, provided in the table below. Let’s calculate the maturity gap and net interest income for the next year if interest rates increase by 2% (200 basis points).

Assets (in millions):

– Floating rate loans (8% annually)

– 20-year fixed rate loans (6% annually)

Liabilities & Equity:

– Current Deposits (5% annually)

– Fixed Term Deposits (5% annually)

Using the table figures, the company’s maturity gap for the next 365 days is:

Interest Rate Sensitive Assets – Interest Rate Sensitive Liabilities

Since the bank has more interest rate sensitive liabilities than assets in this band, the maturity gap is negative. This suggests that an increase in interest rates will likely lead to a decrease in net interest income over this period.

Expected net interest income (in millions) at the end of the year is:

Interest income from Assets – Interest expense from Liabilities

= ($10 x 8%) + ($15 x 6%) – [($12 x 5%) + ($8 x 5%)]

= $0.80 + $0.90 – ($0.60 + $0.40)

= $0.80 + $0.90 – ($0.60 + $0.40)