What Is Static Gap?
Static gap is a measure of exposure or sensitivity to interest rates, calculated as the difference between assets and liabilities of comparable repricing periods.
- Static gap measures the exposure or sensitivity to interest rates. It is the difference between assets and liabilities of comparable repricing periods.
- It can be calculated for short-term, long-term, and multiple time periods and is mainly used for time frames of less than a year.
- The static gap is commonly employed by banks: A bank borrows funds at one rate and loans the money out at a higher rate, with the gap representing its profit.
- Static gap analysis fails to account for many factors, including interim cash flow, average maturity, and prepayment of the loan.
How Static Gap Works
Static gap is a measure of the gap between assets (money held) and liabilities (money loaned out or sensitive to interest) at a set moment in time. Minus signs, or a negative value, in the calculated gap indicate a greater number of liabilities than assets maturing at that particular maturity.
This type of analysis is commonly used in the banking industry. A bank borrows funds at one rate and loans the money out at a higher rate, with the gap, or difference, between the two representing its profit.
Static gap can be calculated for short-term, long-term, and multiple time periods. Usually, it is calculated for time frames of less than a year—often 0 to 30 days or 31 to 90 days.
Example of Static Gap
Suppose a bank has both $5 million in assets and $5 million in liabilities that reprice in any given time window. Changes in interest rates should not change the bank's net interest margin (NIM)—the interest it earns compared to the amount of interest paid out to its lenders. This scenario would represent a balanced gap position.
If instead, $12 million in assets reprice with only $6 million in liabilities repricing, the bank will find itself in an asset sensitive position. In this case, an asset sensitive bank will benefit from a NIM increase if interest rates rise.
In contrast, if only $5 million in assets reprice during the same period that $8 million in liabilities reprice, it is known as a liability sensitive position. Here, if interest rates rise, NIM will decline. Similarly, if interest rates fall the liability-sensitive bank will project a wider NIM.
Limitations of Static Gap
A negative gap doesn’t necessarily always spell bad news for financial institutions (FIs). Yes, when interest rates fall banks earn less from interest-sensitive assets. However, they also pay less on their interest-related liabilities.
In reality, banks that have a higher level of liabilities than assets are the ones that see more of a strain on their bottom line from a negative gap.
Simple static gaps are not always precise and reliable, namely because they fail to consider several important variables that can have a big bearing on interest rate exposure.
There's also the static gap's oversights to take into consideration. Simple static gaps are inherently imprecise measurements because they do not take into account factors such as interim cash flow, average maturity, and prepayment of the loan.
A common, and glaring, hole in gap analysis is its inability to account for the optionality embedded in many assets and liabilities. If rates drop and assets prepay faster than expected, or if rates rise and the average life of assets is unexpectedly extended, these contingencies are typically not a component of simple static gap reporting and analysis.
Other issues arise for non-maturity deposits. Certain deposits are carried in perpetuity, paying for an infinite amount of time.
Static Gap vs. Dynamic Gap
Static gap analysis focuses on the difference between assets and liabilities at one moment in time. Dynamic gap, on the other hand, attempts to measure the gap as time passes and financial obligations change.
Rather than taking a snapshot, this alternative method attempts to track the constant expanding and contracting gap as bank accounts are opened and closed and loans offered to customers and owed to other FIs are approved and paid back.