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above.
Spread Management
Gap Management
Interest rate sensitivity analysis
All the risks that the institution is exposed to, are mainly countered using above mentioned
approaches.
Spread Management
Spread can be defined as the difference between interest earned on deployment of
financial resources and interest earned on required financial resources. Spread is also
known as interest margin.
One of the principle on which bank runs is profitability. To achieve profitability and to
maintain profitability once achieved in the globalised and extremely competitive economic
environment is a big challenge. Targets of profitability directly points towards maximising
spread through various strategies.
Banks are exposed to interest rate risk. Exposure of banks in some asset classes, which
perform cyclically and are not stable income generators, leads banks to have exposure to
cyclical rates. Reducing it helps achieving stabilisation in earnings in long term.
In the era of liberalised economies, banks are exposed to many uncertainties. These
uncertainties might cause unexpected change in rate change which ultimately would affect
the profitability. So, predicting these kinds of rate changes by employing various statistical
tools available would help the bank prepare shield against these risky eventualities.
Banks also need to assess the default risk on deployed financial resources and
accordingly should manage its further investment ensuring good chances of profitability.
This way, probable benefits will balance probable losses and would ensure profitability.
In search of growth, strategies should not aim to achieve extreme targets. Rather, Gradual
improvement in profitability should be targeted to ensured steady and controlled growth.
Gap Management
Gap is essentially the difference between Rate sensitive assets and Rate sensitive
liabilities.
Assets and liabilities which gets impacted by the change in the interest rate are defined as
Rate Sensitive Assets (RSA) & Rate Sensitive Liabilities (RSL) respectively.
Gaps are identified in time buckets which are as under:
1. 1 - 28 days
2. 29 days & upto 3 months
3. Over 3 months & upto 6 months
4. Over 6 months & upto 1 Year
5. Over 1 year & upto 3 years
6. Over 3 years & upto 5 years
7. Over 5 years
8. Non-sensitive
The difference between RSA & RSL is calculated for each time bucket.
Once the benchmark is set, banks which are better equipped to assess rolls-in, rolls-out,
behavioural pattern of various assets and liabilities, classify them in various time buckets
on approval of ALCO
And thus comes the analysis of interest rate sensitivity.
Gap Position