Question

Lizard bank has the gap of -28 millon dollars. according to the bank's analyst, interest rates are going . to accommodate this situation Lizard decided to increase the amount of short-term loans by 8 . interest rates rise from 5% to 6% , what is the expected change in income?

Answer 1

Since Lizard bank has a gap of negative 28 million dollars, it means its interest sensitive liabilities (mostly deposits) exceeds its interest sensitive assets. Now if the expected interest rates is expected to rise, it may be a bad news for the bank, as it may reduce the income of the bank.

In this case the bank in order to tackle the situation, has increased assets by 8 million dollars.

At 5% interest rate the bank has to pay 5% on 28 million = $1,400,000

Now the gap is reduced by adding 8 million dollars in assets. Hence now the gap is $-28 million + $8 million = $-20 million

Now with the increased interest rate of 6%, interest rate obligation is now:

20 million usd * 6% = $1,200,000

The interest obligation is now reduced by $1,400,000 - $1,200,000 = $200,000

Now Lizard bank has to pay $200,000 less interest than earlier.