POSITIVE GAP. A positive Gap in a rising rate environment will increase the net interest margin, Conversely, a declining rate environment will decrease the net interest margin. C) NEGATIVE GAP: A negative Gap in a rising rate environment will decrease the net interest margin, Conversely, a declining rate environment will increase the net interest margin. The effect of the market rate shocks on the NII may also be reviewed for the more extreme rate shocks outward to the plus or minus 200 basis points immediate and permanent rate shocks. This allows management to monitor that the Bank will maintain an adequate capital level even in an extremely adverse rate shock environment. The Bank's ALCO will report the to the Board of Directors the effect of changes on NII not less than quarterly. Gap Analysis: Gap analysis is a static interest rate risk measurement tool because it measures the level of interest rate risk in an existing balance sheet. The completed gap report compares how quickly an institution's assets respond to changes in market rates as compared to its liabilities. Presumably, if one side of an institution's balance sheet responds more quickly to changes in market rates than the other, interest income will change faster (or slower) than interest expense. The gap is the mismatch between the quantity of assets and liabilities repricing in a given period of time. As an interest rate risk management tool Gap has shortcomings identified by three factors. First, it doesn't directly measure the effect of changes on rates on income. Rather it delivers an index of rate sensitivity. Second, its not a very accurate tool for measuring the interest rate risk in complex financial instruments with imbedded options like fixed and adjustable-rate mortgages. Third, because it is a static measurement tool, it can only evaluate the interest rate risk in historical balance sheets. Gap is an ineffective tool for measuring the risk/return tradeoffs between strategies an institution is considering. While Gap is an indicator of the level of interest rate risk in the balance sheet, it can not measure the impact of a change in market rates on earnings. The effect of the placement of the deposits significantly impacts the analysis. Gap analysis provides only rough indicators of interest rate risk. While dollar maturity mismatches are identified, the effects of different repricing rates, periodic repricing limits, floor or ceiling rates, or other factors are not included. Caution is warrante...
