Question

Suppose a bank faces a gap of 15 between its interest-sensitive assets and its interest-sensitive liabilities. What would happen to bank profits if interest rates were to fall by 1 percentage point? You should report your answer in terms of the change in profit per $100 in assets.

A gap of 15 means that the bank has more interest-sensitive (liability/assets) than (liabilities /assets) . When interest rates fall, therefore, bank profits will (fall / rise) because the bank (loses gains) more by paying less on its (assets /liabilities) than it (gains / loses) from receiving less on its (liabilities /assets) . The gap of 15 implies that profits will rise by (15 cents/ $1.50 /$15) per $100 of assets.

if you could explain your answer, that'd be super helpful! thanks.

Answer 1

A gap of 15 means the bank has more interest-sensitive assets than liabilities. If interest rates fall by 1 percentage point, the bank's profits will rise because it saves more on liabilities than it loses on assets, increasing profits by $1.50 per $100 of assets.

Step-by-step explanation:

When a bank experiences a gap in interest rate sensitivity, it means that there's a difference in the maturity or repricing time between its assets and liabilities. A gap of 15 represents that the bank has $15 more in interest-sensitive assets than in interest-sensitive liabilities for every $100 in assets. If interest rates fall by 1 percentage point, the bank's profits will typically rise, as it will be paying less on its liabilities while still receiving higher interest rates on its existing assets that were set before the drop in interest rates.

Therefore, when interest rates fall, the bank's profits will rise because the bank gains more by paying less on its liabilities than it loses from receiving less on its assets. The change in profits for a gap of 15 would be a rise of $1.50 per $100 of assets.

Understanding how the gap affects the bank's profitability is crucial, especially when considering the risk of loan defaults and the asset-liability time mismatch. Banks must manage these risks carefully to maintain profitability and financial stability in fluctuating interest rate environments.