• Global Frameworks: Federal Financial Institutions Examination Council (FFIEC) Uniform Frameworks, IFRS 9 Financial Instruments.

1. Fractional Reserve Banking and Credit Multiplication
Commercial banks operate via a fractional reserve model, transforming short-term liquid deposits into long-term illiquid loans. When a bank receives a deposit, it retains a fraction as cash reserves and lends out the remainder. As these loan proceeds are deposited elsewhere across the banking network, the system generates credit money:
Total Deposit Expansion = Initial Excess Cash Deposit / (Reserve Requirement Ratio + Cash Leakage Rate)
 
2. Asset-Liability Management (ALM) Matrix Risks
Banks face structural balance sheet mismatches because their liabilities (customer deposits) are short-term and volatile, while their assets (commercial loans, mortgages) are long-term and fixed.
  • Interest Rate Risk: If market interest rates rise, a bank’s cost of funding deposits typically increases faster than the yield on its long-term assets, squeezing profit margins.
  • Liquidity Risk: The risk that a bank cannot meet immediate cash withdrawal demands from depositors without selling long-term assets at a severe discount.

3. Structural Measurement: Net Interest Margin (NIM) and Gap Analysis
Banks monitor and manage interest rate risk using two core tool sets:
  • Net Interest Margin (NIM): Measures operational net interest profitability relative to total earning assets:

    NIM = (Interest Income Earned − Interest Expenses Paid) / Average Total Earning Assets
  • Income Gap Analysis: Measures the dollar volume difference between rate-sensitive assets (RSA) and rate-sensitive liabilities (RSL) over a specific time horizon:

    GAP = RSA − RSL

    Δ Net Interest Income = GAP × Δ Interest Rate


    • A Positive Gap (RSA > RSL) means the bank’s net interest income will increase if market interest rates rise.
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