Question

Suppose that your bank buys a T-bill yielding 4% that matures in six months and finances the purchase with a three-month time deposit paying 3%. The purchase price of the T-bill is $3 million financed with a $3 million deposit.

What is the six-month and three-month GAP associated with this transaction? Which is a better GAP measure of the bank's risk?

Answer 1

Six months GAP

Interest sensitive Asset = $ 3 mn T - bills maturing in 6 months

Interest sensitive liability = $ 3mn time deposits rolled over after 3 months for next three months

Hence, six months GAP = Interest sensitive asset - interest sensitive liability = $ 3mn - $ 3 mn = 0

Three months GAP

Interest sensitive Asset = 0 (this is because T - bills are maturing in 6 months)

Interest sensitive liability = $ 3mn time deposits

Hence, six months GAP = Interest sensitive asset - interest sensitive liability = 0 - $ 3 mn = - $ 3 mn

Better measure

The bank is actually having asset liability maturity mismatch. It has an asset that will mature in 6 months time while liability will mature in three months time. Six months GAP fail to capture this as it shows a GAP of 0, while three months GAP captures this adequately which shows a GAP of - $ 3mn. Hence, three months GAP is a better measure of bank's risk.