Gap Reports: Measuring Risk to NII and Economic Value

Measuring Risk to Net Interest Income

After a bank has stratified the bank’s assets, liabilities, and off- balance sheet instruments into time bands and determined how it will treat embedded options, it must measure net interest income (NII) at risk. The formula to translate gaps into the amount of net interest at risk, measuring exposure over several periods, is:

Change in NII = (Periodic gap) x (Change in rate) x (Time over which the periodic gap is in effect)

This formula can be illustrated by applying it to the gap report shown in the table and calculating change in the bank’s net interest income for an immediate 200 basis point increase in rates. For example, the bank has a negative gap of $20 million in the one-month to three-month time band. This means more liabilities than assets will reprice or mature during this time frame. Hence, for the remaining 10 months of the bank’s 12 month time horizon, the bank will have $20 million more of liabilities than assets that have repriced at higher (20 basis points higher) rates. As shown in table the increase in rates reduces the bank’s earnings effect of the banks repricing imbalances over the 12-month horizon is a reduction in net interest income of approximately $362,500.

Sample Net Interest Income Sensitivity Calculation

Time Band	Size of Gap (in millions of dollars)	Basis Point Change	Part of Year Gap is in Effect	Impact on Annualized NII (In thousand of Dollars)
<1 month	$5	200	11.5/12	$95.8
1-3 months	-$20	200	10/12	-$333.3
3-6 months	-$20	200	7.5/12	-$250.0
6-12 months	$25	200	3/12	$125.0
Total				-$362.5

*assumes all repricings occur at midpoint of time band

It is important to stress that this to stress that this method of measuring a bank’s net interest income at risk is very crude and employs numerous simplifying assumptions, including the following: