Business Glossary

asset-liability gap model that takes into account projected future balances or the difference between interest sensitive assets and interest sensitive liabilities at specific future time periods, as opposed to static gap.

repricing or duration mismatch in which interest sensitive liabilities exceed interest sensitive assets. A bank whose interest sensitive liabilities reprice more quickly than interest sensitive assets is said to be liability sensitive.

condition where a bank's interest sensitive assets and interest sensitive liabilitiesare balanced perfectly for a given time period. This state of equilibrium occurs when maturities of assets and liabilities subject to repricing are matched evenly. In reality, this rarely happens because the dynamics of a competitive market make it difficult to match maturities of deposits and loans (a process called matched funding), and because banks, as credit intermediaries, have to take some maturity risk when they make loans. Banks can, however, control the interest rate riskcreated by maturity imbalances by engaging in hedgetactics, such as financial future and interest rate swaps.

the simplest measure of short-term net interest exposure, or difference between assets and liabilities of comparable repricing periods. It generally is calculated for periods under one year, in multiple periods, or time frames of 0 to 30 days, 31 to 90 days, or 91 to 180 days. By itself, interest rate gap is an imprecise measurement, because it fails to consider interim cash flows, loan prepayment, average maturity, and other factors. Contrast with dynamic gap.

maturity or repricing mismatch in a bank's assets and liabilities where there are more assets maturing or repricing in a given period than liabilities. A bank with a positive gap is asset sensitive. The opposite is negative gap.

1. days when bank loans or deposits are subject to a change in interest rate. Interest rates in variable rate consumer loans and adjustable rate mortgages may reprice at scheduled intervals, for example, semiannually or annually, based on changes in an index rate. Other loan and deposit rates can change more frequently, sometimes even daily. A bank with more one-year deposit liabilities changing rates than one-year assets is said to be liability sensitive; if more one-year assets reprice than liabilities, it is asset-sensitive.
2. maturity date of a certificate of deposit or other time deposit that can be renewed (rolled over) at a different rate.

risk that a bank will be unable to refinance maturing deposit liabilities when they come due at maturity, at acceptable prices and terms. When banks go to the market to refinance liabilities, the risk is that they may be unwilling or, in extreme rate volatility, unable to acquire deposits necessary for making new investments. Refinance risk applies to money market deposits and corporate debt, such as term debentures. The risk for the institution is that it may not be able to roll over those liabilities at an affordable rate.

acquiring assets with anticipated maturities, or durations, longer or shorter than the liabilities used to fund those assets. This is the conventional circumstances of bank lending, in other words, borrowing short and lending long, creating interest rate risk that is managed through Asset-Liability Management.

coordination of the maturities of a financial institution's assets (such as loans) and liabilities (such as certificates of deposit and money-market accounts). For instance, a savings and loan might issue 10-year mortgages at 10%, funded with money received for 10-year CDs at 7% yields. The bank is thus positioned to make a threepercentage- point profit for 10 years. If a bank granted 20-year mortgages at a fixed 10%, on the other hand, using short-term funds from money-market accounts paying 7%, the bank would be vulnerable to a rapid rise in interest rates. If yields on the money-market accounts surged to 14%, the bank could lose a large amount of money, since it was earning only 10% from its assets. Such a situation, called a maturity mismatch, can cause tremendous problems for financial institutions if it persists, as it did in the early 1980s.

risk that rates will fall causing cash flows from an investment (dividends or interest), assuming reinvestment, to earn less than the original investment.

situation in Asset-Liability Management when interest-earning assets and interest expense liabilities do not balance. An example is when an asset is funded by a liability of a different maturity. The conventional circumstances in banking are that banks and savings institutions borrow short and lend long. This means funding 30-year mortgages with short-term deposits, expecting that short-term deposits can be rolled over at maturity dates. Also known as a mismatched book. Contrast with matched maturities.

1. ability of current assets to meet current liabilities when due. The degree of liquidity of an asset is the period of time anticipated to elapse until the asset is realized or is otherwise converted into cash. A liquid company has less risk of being unable to meet debt than an illiquid one. Also, a liquid business generally has more financial flexibility to take on new investment opportunities.
2. immediate convertibility into cash without significant loss of value. For example, marketable securities are more liquid than fixed assets, because securities are actively traded in an organized market.