Learning Objectives:

  • Explain the concept of gap analysis and its role in IRRBB measurement.

  • Calculate static gap and earnings sensitivity.

  • Understand the limitations of gap analysis.

3.1 The Concept of Gap Analysis

Gap analysis is a fundamental tool for measuring interest rate risk . The BTRM course covers “ALM and traditional gap analysis” . The NPTEL course includes “Dollar Gap Analysis” and “Earnings Sensitivity Analysis” as part of its ALM module .

Static Gap Analysis: Measures the difference between interest-rate-sensitive assets and liabilities over various time buckets. A positive gap indicates more rate-sensitive assets than liabilities (benefits from rising rates, suffers from falling rates). A negative gap indicates more rate-sensitive liabilities than assets (benefits from falling rates, suffers from rising rates).

Earnings Sensitivity Analysis: Measures the impact of interest rate changes on net interest income .

3.2 Duration Analysis

Duration analysis is a more advanced measure of interest rate sensitivity . The Bocconi course covers the “Duration Gap Model” as part of its interest rate risk management curriculum . The NPTEL course includes “Duration Gap Analysis” in its ALM module .

Duration: A measure of the average time it takes to receive the cash flows from an asset or liability. Duration measures price sensitivity to interest rate changes. The Duration Gap is the difference between the duration of assets and the duration of liabilities, adjusted for leverage.

3.3 Limitations of Gap Analysis

Gap analysis has several limitations:

  • Static Nature: It assumes no changes in the balance sheet composition.

  • No Option-Adjusted Basis: It does not capture the impact of embedded options (e.g., prepayment risk).

  • No Basis Risk: It does not capture basis risk (changes in the relationship between different interest rates).

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