What it means
A bank is a machine that borrows short and lends long, and the machine's gears reprice at different speeds. Some assets and liabilities reset within months, others are locked for years, and the interest rate gap measures the imbalance: rate-sensitive assets minus rate-sensitive liabilities within each time bucket.
The sign tells the story. A bank with more assets than liabilities repricing soon is asset-sensitive, or positively gapped, so rising rates lift its earnings as loans reprice up faster than deposits, while a negatively gapped bank is liability-sensitive, gaining when rates fall and hurting when they rise.
Computing it is bookkeeping discipline: sort every asset and liability into buckets by when it next reprices, a 90-day note into the three-month bucket and a five-year fixed mortgage into its bucket, then net each bucket. The cumulative gap over a year is the traditional headline measure.
The earnings logic is direct, since multiplying the gap by an assumed rate change approximates the first-year earnings impact: a bank with a positive $500 million one-year gap gains roughly $5 million of annual net interest income if rates rise one percentage point, all else equal. All else never is equal, which is the measure's known weakness.
Gap analysis ignores embedded options, like depositors' sticky rates and borrowers' prepayment rights, assumes parallel rate moves, and says nothing about value beyond the horizon, so supervisors treat it as a starting point, not a verdict. Regulators still build on it.
The Comptroller's Handbook on interest rate risk, published by the US Office of the Comptroller of the Currency (OCC), places repricing gap analysis among the fundamental measurement techniques examiners expect, alongside earnings simulations and economic value models, scaled to the bank's complexity. Management uses the gap to choose a posture: a bank expecting rising rates may hold a positive gap deliberately, while one wanting neutrality hedges the mismatch with swaps or balance-sheet restructuring, so the gap is a policy variable, not just a report.
The interest rate gap is the oldest and fastest answer to the question every bank board must ask: which way do we lean on rates? Read its sign, respect its blind spots, and never confuse a one-year earnings gap with the whole of interest rate risk.
In practice
Real-world examples.
Example
A community bank shows $800 million of assets repricing within a year against $500 million of liabilities: a positive $300 million gap that adds roughly $3 million to annual earnings when rates rise one point. The treasurer reports the figure to the board each quarter.
Example
A thrift funded by short-term deposits holds a negative cumulative gap; when rates jump two points, its deposit costs reprice up faster than its fixed mortgage yields and net interest margin compresses sharply. Management then slows new fixed-rate lending until funding terms lengthen.
Example
A bank's finance committee, expecting rate cuts, shifts toward a modestly negative gap by extending funding terms and buying longer bonds, positioning earnings to gain as rates decline. The committee sets a limit on how negative the gap may become.
Formula
Calculation
Gap(bucket) = rate-sensitive assets repricing in bucket minus rate-sensitive liabilities repricing in bucket. Earnings impact, first year, approximately Gap(one-year) x change in rates, holding volumes and spreads constant.
Worked example with assumed figures. A fictional community bank has two buckets inside one year.
- 0 to 3 months: assets $300 million, liabilities $450 million, gap = $300 million - $450 million = -$150 million.
- 3 to 12 months: assets $500 million, liabilities $50 million, gap = $500 million - $50 million = +$450 million.
- Cumulative one-year gap = -$150 million + $450 million = +$300 million, which matches total repricing assets of $800 million less liabilities of $500 million.
If rates rise one percentage point, the approximate first-year gain is $300 million x 0.01 = $3 million; for a two-point rise it is $6 million. The estimate ignores timing within the year, so a more careful model would weight each bucket by the part of the year left after repricing.Case study
Seen in the real world.
Fictional example: Ferrum Savings Bank, a fictional lender, discovers in a board review that rapid growth in fixed-rate mortgages funded by online deposits has swung its one-year gap to negative 40 percent of assets. Its treasurer runs the arithmetic: a two-point rate rise would cut next year's net interest income by nearly a fifth. The bank lengthens deposit terms with promotional certificates, buys longer-dated securities, and adds receive-fixed swaps, pulling the gap toward negative 15 percent. When rates do rise, the margin dip lands within plan, and the examiner's report notes the gap discipline approvingly.
Watch out
Common mistakes.
- Reading the gap as the whole risk. It misses option behaviour like prepayments and sticky deposits, assumes parallel curve moves, and ignores value effects beyond the horizon, which is why supervisors pair it with simulations.
- Mixing maturity with repricing. The gap buckets instruments by when rates reset, not when principal comes due; a five-year floating loan repricing quarterly belongs in the quarterly bucket.
- Managing the gap to zero by default. Neutrality is a choice, not a law; banks deliberately run gaps as rate views, and the discipline is making the posture explicit and limited.
Questions
People also ask.
What is an interest rate gap?
The difference between rate-sensitive assets and rate-sensitive liabilities repricing within a period. Positive means asset-sensitive, gaining when rates rise; negative means liability-sensitive, losing when rates rise.
How is it used in bank management?
As the classic first measure of interest rate risk: multiply the one-year gap by an assumed rate change for a rough earnings impact. Regulators such as the OCC expect it alongside simulations and value models.
What are its limits?
It ignores embedded options like prepayment and deposit stickiness, assumes all rates move together, and captures only short-horizon earnings, not the economic value of the whole balance sheet.
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