Question

3. Consider a bank with the following data: • Interest sensitive assets = $250 million • Interest sensitive liabilities = $300 million a. Calculate the IS-GAP, Relative IS-GAP and IS Ratio of the firm b. Comment on whether the bank has a positive or negative gap and is asset or liability sensitive. Why? c. What happens to the net interest margin (NIM) of this bank when interest rates increase? d. If the ALM team intentionally take this position, what do you think their expectations are concerning the market rates? Explain explicitly.

Answer 1

a.The IS-GAP is going to be= Rate sensitive Assets - Rate sensitive Liabilities = 250-300 =-50 million.

Relative IS-GAP = IS-GAP/Assets = -50/250 = -0.2 = -20%.

IS ratio = RSA/RSL = 250/300 = 0.8333 = 83.33%

b. The bank has a negative GAP and hence it is liability sensitive. This is because the rate-sensitive liabilities are more than the rate-sensitive assets. This means that if interest rates change the effect will be more on the liabilities than the assets.

c. Since the bank is liability sensitive, increasing the interest rates will decrease the NIM because the interest expense will increase more than the interest income.

d. This suggests that the ALM team expects the interest rates to decrease or remain constant because they will benefit out of decreasing interest rates.