Understanding Gap Reports

Gap reports are commonly used to assess and manage interest rate risk exposure-specifically, a banks repricing and maturity imbalances. However, a basic gap report can be unreliable indicator of a bank’s overall interest rate risk exposure. Although a simple gap report does not quantify basis risk, yield curve risk, and option risk, bankers have modified gap reports to do so.

Gap reports stratify all of a bank’s assets, liabilities and off-balance sheet instruments into maturity segments (time bands) based on the instruments next repricing or maturity date. Balances within a time band are then summed (assets are reported as positive amounts and liabilities as negative amounts) to produce a net gap position for each time band. Risk is measured by the size of the gap (the amount of net imbalance within a time band and the length of time the gap is open.

Using properly gap reports, a bank can identify and measure short and long-term repricing imbalances. With this information, a bank can estimate its earnings and economic risks within certain constraints. Gap reports can be particularly useful in identifying the repricing risk of a banks current balance sheet structure before assumptions are made about new business or how to effectively reinvest maturing balances.

Within a given time band, a bank may have a positive, negative or neutral gap. A bank will have a positive gap when more assets reprice or mature than liabilities. Because this bank has more assets than liabilities subject to repricing, the bank is said to be asset sensitive for that time band. An asset sensitive bank is generally expected to benefit from rising interest rates because its assets are expected are expected to reprice more quickly than its liabilities.

Sample Gap Report Schedule

	<1 Mo	1-3Mos	3-6 Mos	6-12 Mos	1-2 Yrs	2-3 Yrs	>3 Yrs	Total
Loans	100	10	20	45	5	20	30	230
Investments		5	5	10	20	20	50	110
Other Assets	5						15	20
Total Assets	105	15	25	55	25	40	95	360
Non maturity Deposits	-65				-30		-50	-145
CDs and Other Liabilities	-35	-35	-45	-30	-10	-10	-20	-185
Total Liabilities	-100	-35	-45	-30	-40	-10	-70	-330
Equity								-30
Net Periodic Gap	5	-20	-20	25	-15	30	25	0
Cumulative Gap	5	-15	-35	-10	-25	5	30	0

A bank has a negative gap and is liability sensitive when more liabilities reprice within a given time band than assets. A bank that is liability-sensitive such as the bank described in the gap report table usually benefits from falling interest rates. In practice, most gap reports will contain more line items and additional time bands.

A bank whose assets equal liabilities within a time band is said to have neutral gap position. A bank in a neutral gap position is not free of exposure to changes in interest rates, however. Although the banks repricing information may be small it can still be exposed to basis risk or changes in rate relationship.

Traditionally, most bankers have used gap report information to evaluate how a bank’s repricing imbalances will affect the sensitivity of its net interest income for a given change in interest rates. The same repricing information, however, can be used to assess the sensitivity of a banks net economic value to a change in interest rates.