Your employer has asked you to examine the interest-rate risk of your bank relat

Question

Your employer has asked you to examine the interest-rate risk of your bank relative to your direct competition. Management is concerned that interest rates will fall by the end of the year and wants to see what would happen to the relative profitability of the firm if the decline actually occurs.

Interest-rate risk depends on each bank's relative position of interest-sensitive assets and liabilities. You begin the analysis by collecting the information and estimates.

1. Compare the impact of estimated net interest income of your bank and your competition if interest rates

    DNIIi = (ISGAPi) DRi = (ISAi - ISLi) DRi

Your bank:

Your competitor:

Decline by 3%

Increase by 3%:  

2 .What is the repricing gap of

GAP = interest rate sensitive assets – interest rate sensitive liabilities

a.Your firm?

b.Your competition?  

Bank Balance Sheet Competition Your Firm Amount Smillions Duration ears Amount Smillions Duration ears 4 0.0 0.0 Reserves and cash items Securities 0.6 1.6 5.0 0.3 1.2 4.0 4 Less than 1 year 1-2 years Greater than 2 years 0.9 4.4 Residential mortgages Variable-rate Fixed-rate (30 years) 0.4 5.5 17 30 30 0.6 1.4 5.4 0.0 Commerical loans 0.9 1.8 6.0 0.0 Less than 1 year 1-2 years 13 31 Greater than 2 years Physical capital 25 10 Liabilities Checkable deposits Money market deposit accounts Savings deposits CDs 1.0 0.5 1.0 14 10 12 6 1.0 0.6 1.0 16 0.4 0.3 1.1 2.9 0.0 12 14 10 10 14 0.6 0.5 1.8 2.2 0.0 Variable-rate Less than 1 year 19 1-2 years Greater than 2 years 15 10 12 39 Fed funds Less than 1 year 1-2 years Greater than 2 years 0.4 1.2 2.9 18 12 31 0.7 1.8 3.8

Explanation / Answer

Variable rates loans and deposits are sensitive to interest rate changes, so that is what we will consider for Duration GAP calculation as per equation given in question.

DNIIi = (ISGAPi) DRi = (ISAi - ISLi) DRi

To interpret this, Total of Net Interest Income is Interest from assets minus Interest towards deposits and duration of the same will be obtained by multiplying the amounts with their respective durations.

In case of the firm,

Interest Income from variable rate assets = $9 Mn

Interest Expense towards variable rate deposits = $6 Mn

Duration Gap of the firm = ($9 Mn - $6 Mn) * 0.4 = $1.2 Mn

In case of the competition,

Interest Income from variable rate assets = $21 Mn

Interest Expense towards variable rate deposits = $12 Mn

Duration Gap of the competition = $21* 0.9 Mn - $12 * 0.6 Mn = $3.6 Mn

Change in NII of firm for 3% decline = -3% of 1.2 Mn = -$36000

Change in NII of firm for 3% increase = +3% of 1.2 Mn = $36000

Change in NII of firm for 3% decline = -3% of $3.6 Mn = -$108000

Change in NII of firm for 3% increase = +3% of $3.6 Mn = $108000

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Repricing Gap of firm = ($9 mn - $6Mn) = $3 Mn

Repricing Gap of competition = ($21 mn - $12Mn) = $9 Mn

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