ALM Basics: GAP Reports
**Note: This post is part of a series on the basics of asset liability management.
One of the first tools used to measure interest rate risk in banks was the GAP report. As the name implies, the report was a measure of the gap between assets that reprice in a time period and the liabilities that reprice in a time period. Gap is still a useful tool, and all ALCO reports should include a gap report of some kind. However, it is no longer the primary tool used in measuring interest rate risk. It was only ever effective in measuring very short term interest rate risk, and has now been replaced by income simulations for that task.
To measure GAP, the bank divides all assets and liabilities into "repricing buckets" or "cash flow buckets." These buckets represent the time period in which the instrument is expected to reprice. Repricing assets are then compared to repricing liabilities in each bucket and cumulatively to see if there is a "gap" or mismatch between the two. The reports generally look something like this:
The GAP is measured by subtracting the repricing liabilities from the repricing assets. A positive number indicates that a bank is asset sensitive, or "positively gapped" for that time period. A negative number indicates that a bank is liability sensitive, or "negatively gapped" in that time frame. Generally a bank looks at the cumulative GAP for the coming 12 months to ascertain if they are asset or liability sensitive. A bank that is asset sensitive should benefit when rates rise (since more assets will reprice than liabilities) and have exposure to rates falling. A liability sensitive bank would have the exact opposite profile.
GAP is useful as a very general estimate, but has several inherent weaknesses the limit its accuracy and effectiveness in measuring true exposure to rate movements. First, while GAP shows the balances that will reprice, it does not show by how much they will reprice given a specified rate movement. Beta, or magnitude, are not captured. In addition, repricing frequency is not captured. A balance that is floating and will reprice on a daily basis cannot be accurately captured in each time bucket and on a cumulative basis.
For these reasons, income simulation and market value of equity are now used to measure exposure to interest rate changes. GAP is useful information, but is better used as a tool to find out why simulation results look the way they do, or as a way to find strategies that will change the exposure if needed.