Question

Currently, interest rates in the economy are the lowest they have ever been. Based on this realization, what should banks do as far as their duration gap and funding gap? Support each answer with one explanatory sentence.

Answer 1

Duration gap will mean that the bank will be trying to match the gap of the duration of their Assets and the liabilities so that there cannot be any kind of liquidity risk associated with their payment and collection so at the current time when the interest rates are very low it will mean that the bank are also having a relaxation in terms of payment but they are are also finding it difficult because their collections are lower.

Commercial banks are generally providing with fixed rate of interest and these rate of interest are not synchronising with the change in the interest rates in the environment and these are exposing the banks to the interest rate risk and funding gap as well so,we should be trying to manage with the liquidity risk by appropriating matching the duration of Assets and liabilities and it can also try to eliminate the risk of interest rate fluctuation by providing with the variable loans.