Question

If a bank has more rate-sensitive assets than liabilities, a fall in interest rates will reduce bank profits, while a rise in interest rates will raise bank profits.

Pl elaborate this statement. Thanks

Answer 1

The Balance Sheet of a bank looks like this

Assets	Amount	Liabilities	Amount
Physical Assets	50	Deposits	90000
Loans	100000	Other Liabilities	5550
Reserves	500	Net Worth	10000
Investment Securities	5000
Total Assets	105550	Total Liabilites	105550

Here,

Deposits on the Liability side is the amount of money the general public has deposited in the bank which they can withdraw anytime (depending upon the type of account)

Loans on the asset side is the amount of money banks has given to the general public from the receipts of deposits.

If the bank has more rate sensitive assets than liabilities, a fall in interest rate will impact the profit and loss account of the bank in the following manner -

Let the Assets are 100% sensitive to rate changes and liabilities are 50% sensitive to rate changes

Therefore, A 50 bps fall in the interest rates will lead to 50bps fall in the interest received on loans and 25bps fall in interest paid on deposits. This means the income of the bank in the form of interest received on loans will go down more than the expenses in the form of interest paid on deposits.

Hence the profits of the bank will go down.