Maturity gap

What Is Maturity Gap?

Maturity gap is a fundamental concept in asset-liability management that measures the difference between the total amount of interest-rate sensitive assets and interest-rate sensitive liabilities that will mature or reprice within a specific future time interval. It provides a crucial metric for understanding a financial institution's exposure to interest rate risk, specifically repricing risk, and its potential impact on net interest income. By analyzing the maturity gap, banks and other financial entities can anticipate how changes in market interest rates might affect their profitability as their assets and liabilities are reset to new rates. A significant maturity gap, whether positive or negative, implies that the institution's earnings are vulnerable to movements in interest rates.

History and Origin

The concept of maturity gap analysis has deep roots in the history of financial institutions, particularly banking and insurance, as they have always faced the inherent challenge of managing mismatched maturities between their assets and liabilities. As financial markets evolved and became more susceptible to fluctuations in interest rates, the need for systematic approaches to mitigate this risk became evident. Formal asset-liability management practices, which include maturity gap analysis, gained prominence in the mid-to-late 20th century, spurred by periods of high and volatile interest rates. The evolution of ALM in these sectors focused on coordinating decisions regarding assets and liabilities to enhance financial stability and optimize risk-adjusted returns. The systematic practice of asset-liability management, encompassing techniques like maturity gap analysis, has been a cornerstone for institutions managing funding and investment objectives, notably influenced by regulatory landscapes.

Key Takeaways

• Exposure Measurement: Maturity gap quantifies an institution's exposure to repricing risk, which is the risk that changing interest rates will affect the profitability of assets and liabilities when they reprice.
• Impact on Net Interest Income: It directly indicates the potential impact of interest rate changes on a financial institution's net interest income over specific time horizons.
• Sensitivity Indicator: A positive maturity gap means that interest-rate sensitive assets exceed interest-rate sensitive liabilities within a given period, suggesting earnings will generally increase with rising rates and decrease with falling rates.
• Inverse Sensitivity: Conversely, a negative maturity gap indicates that interest-rate sensitive liabilities are greater than assets, implying that earnings will tend to increase when rates fall and decrease when rates rise.
• Strategic Planning Tool: Analyzing the maturity gap is a critical tool for strategic decision-making in asset-liability management, helping institutions to manage their overall balance sheet structure and mitigate vulnerabilities.

Formula and Calculation

The maturity gap is calculated by subtracting an institution's rate-sensitive liabilities from its rate-sensitive assets within a defined time bucket. This calculation helps quantify the net exposure to interest rate changes for that specific period.

The formula for maturity gap is:

$\text{Maturity Gap} = \text{Rate-Sensitive Assets} - \text{Rate-Sensitive Liabilities}$

Where:

• Rate-Sensitive Assets refer to assets (e.g., loans, investments) whose interest rates will change or which will mature within the specified time interval.
• Rate-Sensitive Liabilities refer to liabilities (e.g., deposits, borrowings) whose interest rates will change or which will mature within the specified time interval.

Financial institutions typically categorize their assets and liabilities into various time buckets (e.g., 0-30 days, 31-90 days, 91-180 days, 181-365 days, over 1 year) to assess the maturity gap across different horizons.

Interpreting the Maturity Gap

Interpreting the maturity gap involves understanding how its sign and magnitude influence a financial institution's net interest income in response to changes in prevailing interest rates.

• Positive Maturity Gap: When an institution has a positive maturity gap, it means its interest-rate sensitive assets are greater than its interest-rate sensitive liabilities for that time bucket. In this scenario, if interest rates rise, the income generated from assets will reprice upward faster or to a greater extent than the expense of liabilities, leading to an increase in net interest income. Conversely, if rates fall, net interest income would likely decrease.
• Negative Maturity Gap: A negative maturity gap occurs when interest-rate sensitive liabilities exceed assets. Here, if interest rates rise, the cost of liabilities will increase more quickly or significantly than asset income, resulting in a decrease in net interest income. If rates fall, net interest income would likely increase.
• Zero or Balanced Maturity Gap: An institution aiming for a zero maturity gap seeks to have its rate-sensitive assets roughly equal to its rate-sensitive liabilities. This strategy attempts to insulate net interest income from the effects of interest rate fluctuations.

The interpretation also considers the shape and expected shifts of the yield curve. For example, a positive gap might be desirable in a rising rate environment, while a negative gap might be preferred when rates are expected to fall. Management uses this insight to adjust the composition of their balance sheet to align with their interest rate outlook and risk appetite.

Hypothetical Example

Consider a hypothetical commercial bank, "DiversiBank," analyzing its maturity gap for the next 90 days.

DiversiBank's Rate-Sensitive Items (Next 90 Days):

• Rate-Sensitive Assets:

  • Short-term loans repricing in 60 days: $500 million
  • Floating-rate securities resetting in 30 days: $300 million
  • Total Rate-Sensitive Assets = $800 million

• Rate-Sensitive Liabilities:

  • Money market deposits repricing in 30 days: $600 million
  • Short-term borrowings maturing in 45 days: $400 million
  • Total Rate-Sensitive Liabilities = $1,000 million

Calculation of Maturity Gap:

$\text{Maturity Gap} = \text{Rate-Sensitive Assets} - \text{Rate-Sensitive Liabilities}$
$\text{Maturity Gap} = \$800 \text{ million} - \$1,000 \text{ million}$
$\text{Maturity Gap} = -\$200 \text{ million}$

Interpretation:

DiversiBank has a negative maturity gap of -$200 million for the next 90 days. This means that within this period, the bank has $200 million more in liabilities that will reprice or mature than assets.

• Scenario 1: Interest Rates Rise by 0.50%

  • Income from assets would increase by roughly $800 million * 0.50% = $4 million.
  • Expense from liabilities would increase by roughly $1,000 million * 0.50% = $5 million.
  • Change in net interest income = $4 million (increase in income) - $5 million (increase in expense) = -$1 million.
  • The negative maturity gap leads to a decrease in net interest income when rates rise.

• Scenario 2: Interest Rates Fall by 0.50%

  • Income from assets would decrease by roughly $800 million * 0.50% = $4 million.
  • Expense from liabilities would decrease by roughly $1,000 million * 0.50% = $5 million.
  • Change in net interest income = -$4 million (decrease in income) - (-$5 million) (decrease in expense) = +$1 million.
  • The negative maturity gap leads to an increase in net interest income when rates fall.

This example illustrates how DiversiBank's negative maturity gap makes its net interest income vulnerable to rising interest rates but potentially beneficial from falling rates.

Practical Applications

Maturity gap analysis is a critical component of risk management for a wide range of financial institutions. Its practical applications span several key areas:

• Banking Sector: Commercial banks heavily rely on maturity gap analysis as part of their asset-liability management framework. It helps them manage the interest rate sensitivity of their loan portfolios and deposit bases. Regulators, such as the Office of the Comptroller of the Currency (OCC), emphasize sound interest rate risk management practices, which include assessing the maturity gap. The OCC provides guidance on sound risk management practices to manage interest rate risk exposures within banks.
• Treasury and Investment Management: Financial institutions' treasury departments use maturity gap analysis to structure their investment portfolios and funding sources. By aligning the repricing characteristics of assets and liabilities, they can optimize net interest income and manage risk.
• Corporate Finance: Large corporations with significant debt and investment portfolios may also apply maturity gap principles to manage their exposure to changing interest rates. This can influence decisions on the issuance of fixed-rate assets versus variable-rate liabilities or vice versa.
• Monetary Policy Impact Assessment: Understanding the aggregate maturity gaps across the financial system can provide insights into how central bank actions, such as changes in the federal funds rate, will transmit through the economy. Central banks influence short-term interest rates to affect the availability and cost of credit, which in turn impacts the economic decisions of businesses and households. This influence directly impacts the repricing of assets and liabilities and thus the maturity gap.

Limitations and Criticisms

Despite its utility, maturity gap analysis has several limitations and criticisms:

• Static Measure: Maturity gap is a static snapshot of interest rate risk at a given point in time. It does not dynamically account for changes in customer behavior, such as early withdrawals of deposits or prepayments of loans, which can significantly alter the effective maturity or repricing periods of assets and liabilities.
• Parallel Shift Assumption: A common criticism is that maturity gap analysis often assumes parallel shifts in the yield curve. In reality, the yield curve can twist, flatten, or steepen, meaning short-term rates may move differently from long-term rates. This non-parallel movement can lead to inaccurate predictions of interest income sensitivity.
• Neglect of Embedded Options: Many financial products, such as callable bonds or mortgages with prepayment options, contain embedded options that allow either the issuer or the borrower to alter the cash flow stream based on interest rate movements. Maturity gap analysis typically does not adequately capture the value or risk associated with these embedded options.
• Does Not Account for Market Value Risk: Maturity gap analysis primarily focuses on the impact on net interest income (earnings perspective) rather than the change in the economic or market value of the institution's balance sheet (economic value perspective). While income is important, significant changes in asset and liability values due to interest rate swings can threaten an institution's capital adequacy. Research on asset-liability management approaches, such as those used by the Federal Reserve, indicates that while certain strategies might minimize net income volatility, they might maximize mark-to-market asset volatility, suggesting trade-offs not fully captured by simple maturity gap analysis. This highlights that a narrow focus on income effects can overlook significant capital risks.
• Complexity with Diverse Portfolios: For institutions with highly complex and diverse portfolios of assets and liabilities, categorizing everything into simple time buckets for maturity gap analysis can be overly simplistic and fail to capture the nuances of their interest rate risk exposure.

Maturity Gap vs. Duration Gap

While both maturity gap and duration gap are tools used in asset-liability management to assess interest rate risk, they measure different aspects of this risk and serve distinct purposes.

Maturity gap analysis essentially tells an institution how much of its balance sheet will reprice or mature within a given period. Duration gap, on the other hand, measures the overall sensitivity of an institution's net worth to changes in interest rates by considering the timing and magnitude of all expected cash flows. While maturity gap is simpler and provides a quick assessment of short-term earnings vulnerability, duration gap offers a more refined and comprehensive measure of market value [interest rate risk](https://diversification