Gap analysis is a simplistic IRR measurement model used by small or non-complex institutions that provides an easy way to identify repricing gaps. It can also be used to estimate how changes in rates will affect future income. However, gap analysis has several weaknesses and is generally not sufficient as the sole IRR measurement model for other than small credit unions. Gap analysis can be a first step in identifying IRR exposures and may serve as a reasonableness check for more sophisticated forms of IRR measurement models.
Gap analysis helps identify maturity and repricing mismatches between assets and liabilities. Gap segregates a credit union’s rate-sensitive assets from rate-sensitive liabilities, according to their repricing characteristics. Then the analysis summarizes the repricing mismatches for a defined time horizon. Additional calculations can then estimate the effect the repricing mismatches may have on NII.
Gap analysis may identify periodic, cumulative, or average mismatches. It may show the ratio of rate-sensitive assets and rate-sensitive liabilities, divided by average assets or total assets. However, using those denominators does not produce a standard gap ratio. It simply provides other ways of describing the degree of repricing mismatches.
A credit union has a positive gap if the amount of rate-sensitive assets repricing in a given period exceeds the amount of rate-sensitive liabilities repricing during the same period. When a credit union has a positive gap, it is considered asset sensitive. Should market interest rates decrease, a positive gap indicates that NII would likely decrease. If rates increase, a positive gap indicates that NII may increase.
Conversely, a credit union has a negative gap when the amount of rate-sensitive liabilities exceeds the amount of rate-sensitive assets repricing during the same period. When a credit union has a negative gap, it is considered liability sensitive, and a decrease in market rates would likely cause an increase in NII. Should interest rates increase, a negative gap indicates NII may decrease.
Only smaller and non-complex credit unions with very simple balance sheet structures should consider relying solely on gap analysis for IRR measurements.
Last updated October 11, 2016
