Duration Gap Analysis for Banks
Duration gap tells you how exposed a bank is to interest rate changes by comparing the average repricing timeline of its assets against its liabilities. A larger gap means more sensitivity to rate movements, in either direction.
How It Works
Every asset and liability on a bank's balance sheet has a duration, which measures how long it takes for the instrument to reprice or mature. A 30-year fixed-rate mortgage has a long duration. An overnight federal funds borrowing has a duration near zero. A bank's duration gap is the weighted average duration of its assets minus the weighted average duration of its liabilities.
When the gap is positive, assets take longer to reprice than liabilities. Rising rates hurt in the short term because the bank's funding costs increase before its asset yields catch up. Falling rates help, because funding costs drop while asset yields hold steady for longer.
A negative gap works in reverse. Assets reprice faster, so rising rates provide an immediate earnings boost.
Reading Duration Gap Disclosures
Banks report rate sensitivity in their 10-K and 10-Q filings, typically in a table showing estimated changes to net interest income (NII) and economic value of equity (EVE) under rate shock scenarios. The NII sensitivity shows the near-term earnings impact over 12 months. The EVE sensitivity shows the longer-term balance sheet impact.
A bank reporting that a +200 basis point shock would reduce NII by 8% has meaningfully more rate exposure than one showing a 2% reduction. Neither number alone is good or bad; it depends on whether the bank is being compensated for that risk through higher current margins.
What to Watch For
Compare duration gap disclosures across banks of similar size and business model. A community bank focused on fixed-rate residential mortgages will naturally run a longer duration gap than one focused on adjustable-rate commercial real estate loans. The question is whether the gap is intentional and managed, or simply a byproduct of the loan mix.
Look for changes over time. A bank that significantly increases its duration gap between reporting periods has made a bet on the direction of rates, whether explicitly or not. Shrinking gaps suggest the bank is de-risking, possibly in anticipation of rate volatility.
Related Articles
- Asset-Liability Management in Banking — How banks actively manage the duration gap through ALM processes
- Yield Curve Impacts on Bank Profitability — How the yield curve shape interacts with duration positioning
Related Metrics
- Net Interest Margin (NIM) — Duration gap directly determines how NIM responds to rate changes