Maturity Gap

Maturity gap is a measurement of interest rate risk for risk-sensitive assets and liabilities. Using the maturity gap model, the potential changes in the net interest income variable can be measured. In effect, if interest rates change, interest income and interest expense will change as the various assets and liabilities are repriced.

A bank is exposed to liquidity risk, that is, the risk that it will have inadequate cash to meet its funding requirements. To ensure that it has an adequate level of cash for its operations the terms of maturity of its assets and liabilities must be monitored. If the gap between the maturities of assets and liabilities held is very large, the bank may be forced to seek relatively expensive “money at call” borrowings.

The maturity of each asset or liability defines an interval that must be assessed. The interval is the gap that is present between the cost of owning assets and liabilities that generate interest income and the degree of risk or volatility of the holdings. The maturity gap analysis compares the value of assets that either mature or are repriced within a given time interval to the value of liabilities that either mature or are repriced during the same time period (Reprice means the potential to receive a new interest rate). To understand the gap, assets and liabilities are grouped according to their maturity or repricing intervals. For example, assets and liabilities due to mature in less than 30 days are grouped together, assets and liabilities with a maturity date between 270 and 365 days are included in the same category, and so on. Longer repricing periods have a higher sensitivity to interest rate changes and are subject to change within a year. An asset or a liability with an interest rate that cannot change for more than a year is considered fixed.

The maturity gap is the weighted-average time to maturity of financial assets less the weighted-average time to maturity of liabilities. The market values at each point of maturity for both assets and liabilities are assessed, then multiplied by the change in interest rate and summed up to calculate the net interest income or expense. The resulting value can be expressed either in dollars or in percentage of total earning assets.

For example, the balance sheet for the company is provided in the table below. Let’s calculate the net interest income (or expense) at year-end if interest rates increase by 2% (or 200 basis points).

Using the figures in the table, the company’s expected net interest income at the end of the year is:

Interest income from Assets – Interest expense form Liabilities

= ($10 x 8%) + ($15 x 6%) – [($12 x 5%) + ($8 x 5%)]

= $0.80 + $0.90 – ($0.60 + $0.40)

= $1.7 - $1

Expected Net Interest Income = $0.70, or $700,000

If interest rates increase, let’s see how the change will affect the company’s expected net interest income using maturity gap analysis. Multiply the market values by change in interest (2%), bearing in mind that the rate sensitive or floating assets and liabilities will be affected by the change in rates.

Assets – Floating rate loans: $10 x (8% + 2%) = $1

                Fixed rate loans: $15 x 6% = $0.90

Liabilities – Current deposits: $12 x (5% + 2%) = $0.84

Fixed term deposits: $8 x 5% = $0.40

Calculate the net interest income by adding the resultant values together.

Net Interest Income = $1 + $0.90 + (-$0.84) + (-$0.40)

Net Interest Income = $0.66, or $660,000

If interest rates increase by 2%, the expected net interest income will decrease by $40,000. If interest rates declined by 2% instead, the net interest income will increase by $40,000 to $740,000.

The maturity gap method, while useful, is not as popular as it once was due to the rise of new techniques in recent years. Newer techniques such as asset/liability duration and value at risk (VaR) have largely replaced maturity gap analysis.