If a bank is characterized by a positive income gap and interest rates rise, what will...

If a bank is characterized by a positive income gap and interest rates rise, what will happen? What will happen if the bank is characterized by a negative income gap and interest rates rise? How would your answer to these questions change if we assumed that interest rates were falling? How can banks insulate themselves from the threat posed by volatile interest rates on bank income?

Expert Solution

The bank gap = Rate sensitive assets - Rate sensitive liabilities

Net Interest Income = Interest income(Earned on mortgages) - Interest expense (Paid to deposits)

1). positive income gap and interest rates rise - Interest income will rise , Interest expense will rise, Net Interest Income will rise.

2). negative income gap and interest rates rise - Interest income will rise , Interest expense will rise, Net Interest Income will fall.

3). positive income gap and interest rates fall- Interest income will fall, Interest expense will fall, Net Interest Income will fall.

4). negative income gap and interest rates fall- Interest income will fall, Interest expense will fall, Net Interest Income will rise.

Banks can insulate themselves from monitoring the dollar amount of rate-sensitive assets and adjusting appropriately.
Banks can use derivatives such as interest rate swaps to manage the volatility in interest income.

jeff jeffy answered 2 years ago

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