Question

Essay: "Explain and discuss the purpose and implementation of (i) gap analysis for liquidity risk and interest rate risk, and (ii) credit risk management."

Answer 1

(I) gap analysis means that maturity gap of assets as well as liabilities are matched in order to reduce the risk associated with interest rate fluctuations and liquidity risk.

Gap analysis will be focusing upon matching the securities maturity in order to reduce the fluctuation in the interest rate and improve the liquidity of the bank as assets with higher time frame will be matched with liabilities with higher time frame so there would be a better management of a liquidity because it will prevent the bank from running out of of cash to repay the debt because it will be matching the assets with liabilities and it will be able to fund its liabilities in a proper manner.

Implementation of gap analysis will also be helpful in interest rate fluctuation because there are long securities which are high sensitive to interest rate changes and these are are properly managed with their ability so that these interest rate fluctuation does not affect the overall asset quality of the bank and liquidity position of the bank.

(B) gap analysis would also be helpful in credit risk management because maturities of asset will be matched with maturity is of liabilities in order to eliminate the the credit risk arising out of non payment of debt.

Credit risk is usually related to non-payment of principal payments and these are generally attributed to mismanagement of Assets and liabilities as long-term assets are funded by short term liabilities and short term assets are funded by long-term liabilities, so it will be impacting the cash flows of the company and it can also impact the company overall solvency by posing a risk on default of these repayment of principal so it can be summarised that gap analysis would be leading to to credit risk management.