Question

Compare and contrast income gap and duration gap analysis as techniques for management of interest rate risk by banks.

Answer 1

Duration gap analysis of a bank will be reflecting the the ability of the bank in order to match the duration of its securities so that it can protect itself against any kind of interest rate fluctuation.

Duration gap is often known as the duration of the Assets and the liability maturity that have been held by the bank.

if the duration of the assets are higher than the duration of the liability , then the duration gap will be positive and if the duration of liabilities are higher than the assets, then the duration gap is negative.

income gap is calculated by changes in the income of the bank due to the price sensitivity to the interest rate changes.

these kind of income gaps are generally considered operational in nature and this income gap are mostly related to expenses and income which are short term in nature.

Duration gap are mostly caused by non matching of the duration whereas income gaps are generally caused by the price sensitivity changes of income due to fluctuation in interest rate.

So, this both are the different concepts and they need to be managed efficiently by the bank in order to achieve its objective.