Determining Interest Rate Risk
It’s important to remember that although you might only be concerned with how much an interest rate might cost you over the lifetime of your credit card account or mortgage, the banks also take on some risk when they agree to certain interest rate amounts. It’s important for banks to set and maintain reasonable levels, both for themselves and their borrowers, which can be very hard to do given the current state of the market. Failing to properly assess the risk involved will result in a maturity gap, and could mean bad news for the banks.
In its simplest terms, a maturity gap is the measurement of the level of interest rate risk for risk-sensitive assets and liabilities held by a particular financial institution. This could apply to big banks, or to your small business, depending on the nature of your services. When using this gap for evaluation purposes, the market values at each point of maturity are carefully examined, for both assets and liabilities, and then these values are multiplied by the change in interest rate and added together to calculate the net interest expense or income. While still useful in some instances, this method has been largely replaced by newer techniques.