Question

After an internal audit, your bank has determined that it has a negative repricing gap. What sort of risk are you concerned about, and how can you remediate it? a. Underwriting risk; tighten credit requirements. b. Liquidity risk; enter the repo market. c. Currency risk; arrange a currency swap. Interest rate risk; arrange an interest rate swap. Off-Balance Sheet Risk; arrange swaps swaptions or forwards at the time the loan commitment is made.

Answer 1

Interest rate risk; arrange an interest rate swap

A negative repricing gap implies that the interest sensitive liabilities of the bank are greater than the interest sensitive assets of the bank. This increases the interest rate risk because if the interest rate increases the liabilities are repriced at a higher rate. This will decrease the net income of the bank. In this scenario it will be beneficial for the bank to arrange an interest rate swap which is essentially a forward contract in which a certain stream of future cash flows are exchanged for another.