1. Bank Management & Financial Services (6th Edition) by Rose & Hudgins
Asset-Liability Management: Determining and Measuring Interest Rates and Controlling Interest-Sensitive and Duration Gaps
Bank Management & Financial Services (6th Edition) by Rose & Hudgins
G. M. Wali Ullah
Lecturer
Independent University, Bangladesh (IUB)

2. ASSET-LIABILITY MANAGEMENT
The Purpose of Asset-Liability Management is to-
Control a Bank’s Sensitivity to Changes in Market Interest Rates and
Limit its Losses in its Net Income or Equity

3. ASSET-LIABILITY MANAGEMENT
NET INTEREST MARGIN
INT REVENUE
INT COSTS
MKT VALUE OF ASSETS
MKT VALUE OF LIABILITIES
INVESTMENT VALUE, PROFITABILITY AND RISK
Response to changing IR
NET WORTH

4. Market Interest Rates Function of: Risk-Free Real Rate of Interest
Various Risk Premiums
Default Risk
Inflation Risk
Liquidity Risk
Call Risk
Maturity Risk

5. Yield Curves
Graphical Picture of Relationship Between Yields and Maturities on Securities
Generally Created With Treasury Securities to Keep Default Risk Constant
Shape of the Yield Curve
Upward – Long-Term Rates Higher than Short-Term Rates
Downward – Short-Term Rates Higher than Long-Term Rates
Horizontal – Short-Term and Long-Term Rates the Same

6. Yield Curves

7. Interest Rate Hedging
To protect profits against adverse changes in interest rates, management tries to hold fixed the Net Interest Margin (NIM)
Management aims to Insulate the Bank from the Damaging Effects of Fluctuating Interest Rates on Profits

8. Interest-Sensitive Gap Management

9. Interest-Sensitive Gap Management
Interest-Sensitive Assets:
Interest-Sensitive Liabilities:
Short-Term Securities Issued by the Government and Private Borrowers
Short-Term Loans Made by the Bank to Borrowing Customers
Variable-Rate Loans Made by the Bank to Borrowing Customers
Borrowings from Money Markets
Short-Term Savings Accounts
Money-Market Deposits
Variable-Rate Deposits

10. Interest-Sensitive Gap Management
Asset-Sensitive Bank
Liability-Sensitive Bank
Interest Rates Rise
NIM Rises
Interest Rates Fall
NIM Falls
Interest Rates Rise
NIM Falls
Interest Rates Fall
NIM Rises

11. Important Decision Regarding IS Gap
Management Must Choose the Time Period Over Which NIM is to be Managed
Management Must Choose a Target NIM
To Increase NIM Management Must Either:
Develop Correct Interest Rate Forecast
Reallocate Assets and Liabilities to Increase Spread
Management Must Choose Volume of Interest-Sensitive Assets and Liabilities

12. Aggressive Interest-Sensitive Gap Management
Expected Change in Interest Rates
Best Interest-Sensitive Gap Position
Aggressive Management’s Likely Action
Rising Market Interest Rates
Positive IS Gap
Increase in IS Assets
Decrease in IS Liabilities
Falling Market Interest Rates
Negative IS Gap
Decrease in IS Assets
Increase in IS Liabilities

13. Eliminating Interest-Sensitive Gap
IS GAP
THE RISK
POSSIBLE MANAGEMENT RESPONSE
Asset sensitive
Losses if interest rates fall (NIM will be reduced)
Do nothing
Extend asset maturities or shorten liability maturities
Increase ISL or reduce ISA
Liability sensitive
Losses if interest rise (NIM will be reduced)
Shorted asset maturities or lengthen liability maturities
Decrease ISL or increase ISA

14. Problems with Interest-Sensitive Gap Management
Interest Paid on Liabilities Tend to Move Faster than Interest Rates Earned on Assets
Interest Rate Attached to Bank Assets and Liabilities Do Not Move at the Same Speed as Market Interest Rates
Point at Which Some Assets and Liabilities are Repriced is Not Easy to Identify
Interest-Sensitive Gap Does Not Consider the Impact of Changing Interest Rates on Equity Position