What is Rate Sensitive Gap

Rate sensitive gap is used in the context of banks; it can be defined as the difference between the rate sensitive assets and liabilities of the bank. Rate sensitive assets are those assets which are vulnerable to changes in the interest rates; it includes floating rate loans given by banks to individuals. As far as rate sensitive liabilities are concerned it includes floating rate deposits in the banks. Knowledge of rate sensitive gap can be very helpful for a bank if it wants to profit from the interest rate fluctuations.

If a bank thinks that interest rates will be rising in near future then it would like to have a positive rate sensitive gap that is giving more floating rate loans and accepting less floating rate deposits because as interest rate rise bank will have to pay more interest to deposit holders and also it will take more interest from borrowers.

However if bank excepts that interest rate will decline in near future then it will try to make rate sensitive gap negative that is accepting more deposits than giving loans. It is not easy to forecast interest rates during extreme volatility in interest rates and therefore banks try to keep rate sensitive gap near zero during those times so as to maintain their margins.

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