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On page 363 of the official Liquidity Risk book, we have below table, can someone help me understand the #2 point under the "possible management responses" column?
My understanding is when we have a positive gap, we should reduce asset maturity or increase liab maturity, why the book says the opposite?

Table 18.2.jpg
 
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David Harper CFA FRM

David Harper CFA FRM
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Hi @danielyyq and @chintanmatalia I agree that #2 is incorrect. This is a new 2020 reading, and I haven't entirely analyzed it, but i can see that it maybe lacks some consistent FRM-consisten vocabulary. Regardless, I think we can see how #2 must be a mistake. The author defines asset sensitive as when interest-sensitive assets > liabilities. Liability sensitive is when assets < liabilities; e.g., his/her own example is on the prior page: a cumulative gap of -$600.0 million reflects ($100 mm in interest-earning assets per month * 6 months) - ($200 mm liabilities * 6) = -600. If market rates increase by +1.0%, then the bank suffers a +1% * -600 = -$6.0 million loss. So the first two columns in Table 18.2 are consistent, but they don't incorporate duration as the author explains:
"While interest-sensitive gap management works beautifully in theory, practical problems in its implementation always leave financial institutions with at least some interest-rate risk expo-sure. For example, interest rates paid on liabilities (which often are predominantly short term) tend to move faster than interest rates earned on assets (many of which are long term). Then, too, changes in interest rates attached to assets and liabilities do not necessarily move at the same speed as do interest rates in the open market. In the case of a bank, for example, deposit interest rates typically lag behind loan interest rates." -- 2020 Financial Risk Management Part II: Liquidity and Treasury Risk Measurement and Management, 10th Edition [VitalSource Bookshelf version]. Retrieved from vbk://9780136595700
... so this gap perspective only refers to incremental impact of rates change on the net interest margin (it only cares NIM and assumes a rate change impacts any asset/liability dollar balance equally because it's only the incremental income statement impact), it does not reflect change in value due to duration. Put simply, this measure does not account for balance sheet impact; i.e., change in market value of assets/liabilities. That's why the author creates a weighted interest-sensitive gap where he/she multiplies the account balance by a weight that reflects duration; e.g., loans get a 1.5. Under this weighting, if we want to reduce an asset sensitive gap, we would reduce asset maturity (decrease asset duration and lower the multiplier) and/or extend liability maturity (increase liability duration and increase the multiplier) such that the we lower the gap. So, yea, I totally agree with @danielyyq. Thank you for pointing this out!
 
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