QUESTION 1 If an FI\'s repricing gap is less than zero, then it is deficient in
ID: 2807563 • Letter: Q
Question
QUESTION 1
If an FI's repricing gap is less than zero, then
it is deficient in its required reserves.
it is deficient in its capital ratio requirement.
its liability costs are more sensitive to changing market interest rates than are its asset yields.
its liability costs are less sensitive to changing market interest rates than are its asset yields.
the duration of the FI's liabilities exceeds the duration of FI's assets.
it is deficient in its required reserves.
it is deficient in its capital ratio requirement.
its liability costs are more sensitive to changing market interest rates than are its asset yields.
its liability costs are less sensitive to changing market interest rates than are its asset yields.
the duration of the FI's liabilities exceeds the duration of FI's assets.
Explanation / Answer
If an FI's repricing gap is less than zero, then
Answer: its liability costs are more sensitive to changing market interest rates than are its asset yields.
Explanation:
In case of banks and FIs, liabilities are generally for short period and assets are for longer duration. Banks or FIs keep rolling their short-term liabilities at lower rates this is because short-term liabilities pose low interest cost. Example, LIBOR rate for 6 months will be lower than 1-year LIBOR.
The situation for FIs generally remains favorable when they finance long-term asset (lending) with their short-term liability (borrowing) but in non-ideal situations or tight market conditions the short-terms rates rise and the borrowing costs goes up. The depositors demand high interest rate for providing liquidity hence, the FIs end up paying more on their short-term borrowings against earning from their assets. Therefore, the liability costs in such situations become more sensitive to changing market interest rates than the asset yields. The situation results in negative or less than zero repricing gap.
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