BANK MANAGEMENT
Bank A analysis
- Calculation of the net interest income, net interest margin, and GAP of Bank A.
The net interest income is the residual earnings of a company obtained after all deductions such as expenses have been made on the sales. It forms the end profit or loss after the deduction of all expenditures from the net cash flow of an organization. Some of the information provided in the BANK A balance sheet are primary assets and liabilities like the fixed rate, the rate sensitive as well as the non-earning payment made. Based on the available information, the net interest income is calculated as:
Net interest income = Revenues generated by interest-bearing assets – cost of servicing liabilities ().
The revenue generated by the interest bearing assets of Bank A includes the fixed rate and the rate sensitive.
Rate sensitive = £400 MM
Fixed rate assets = £450 MM
The revenue generated by the interest bearing assets is therefore; = £400 MM + £450 MM
= £850 MM
The bank serving liabilities include the rate sensitive and fixed rate given as £600 MM and £200 MM respectively. Therefore, the cost of servicing liabilities = £600 MM + £200 MM
= £800 MM
Net interest income = £850 MM – £800 MM
= £50 MM
Net interest margin forms the measurement of the existing difference between generated interest income by the bank and the interest amount paid to leaders in relation to assets available.
Net interest margin = (interest income – interest expenses)/average earning assets
= (£50 MM – 0)/£850 MM
= £50 MM/£850 MM
=1/17
= 0.0588
The GAP of Bank A forms the distance found between the organization assets and liabilities, that is the difference between the lending and borrowing rates of the bank
GAP of Bank A = Assets – liabilities
= £1000 – £1000
= £0
- Assume that there is a parallel shift in rates by +2% (that is +200bps). Explain the expected impact of this parallel shift on
Initially, the GAP of BANK A has been evaluated to stand at 0%, considering that the assets and liabilities of the banks are equal (£1,000). Assuming a parallel shift in the rates by 2% in terms of rate some of the impacts are highlighted below
Net interest income = Revenues generated by interest-bearing assets – cost of servicing liabilities
The interest bearing assets are more costly compared to the interest bearing liabilities (Ahtik, Banerjee, and Remsak, 2016). This implies that a constant increase in the interest rate by 2% will increase the value net interest income as the assets will be higher than the liabilities in the long run.
An increase in 2% indicates that the rate sensitive assets will be = 107/100 * 400 = 428 MM while the fixed rate assets will be 109/100 * 450 = 490.5 MM
Total revenue generated by interest bearing assets = 918.5
In general, the net interest income increases with the positive parallel shift
Net interest margin = (interest income – interest expenses)/average earning assets
The positive parallel increase in the rate of income generating assets will cause a rise in the average earning assets total while increasing the interest expenses. This implies that the net interest margin is expected to be negative.
III. Calculate the new net interest income and net interest margin given a +1% (i.e. 100 bps) parallel shifts in rates.
The new net interest income and net margin following a positive 1% parallel shift in rate will be evaluated as follows
New value of the sensitive assets = 106/100 * £400
= 424 MM
New value of fixed rate assets = 108/100 * £450
= £486 MM
The New value of the sensitive liabilities = 102/100 * 600
= 612 MM
New fixed rate liabilities = 103/100 * 200
= 206
Thus, the New Net Interest Income = [424 MM + £486 MM] – [612 MM + 206]
= £92 MM
The net interest margin = (1006 – 1018)/910
= -12/910
= – 0.013%
BANK B
- Calculate the weighted average duration of assets, the weighted average duration of the liabilities, net interest income, net interest margin, and the DGAP of Bank B.
The weighted average duration of assets forms the time measurement of sensitivity of the bond interest rate depending on the weighted average of time period of the bond cash flow that the bond holder cruises.
But Duration Gap = Weighted Avg Duration of Assets – (Liabilities/Total Assets) implying that the weighted average duration of assets = Gap + (Liabilities/Total Assets) (Brummelhuis and Luo, 2019)
= 6 + (£1000/£1000)
= 6 -1
= 5
The weighted average duration of liabilities = (800/1,250)*3.75 years + (250/1,250)*7.25 years = 3.85
Net interest income = Revenues generated by interest-bearing assets – Cost of servicing liabilities
= 800 – 900
= – 100
Net interest margin = Total assets – total liabilities
DGAP of Bank B = 1,000 – 1,000
= 0
- Assume that there is a parallel shift in rates by +1% (i.e. +100bps). Explain the expected impact of this parallel shift on net interest income and net interest margin given the DGAP calculated in part (B.i)?
A positive parallel shift in the rates by 1% is likely to increase the value of the net interest margin and lower the amount of the net interest income. This implies that the net interest margin is expected to be negative (Brummelhuis and Luo, 2019). A constant increase in the interest rate by 2% will increase the value net interest income as the assets will be higher than the liabilities in the long run.
- Calculate the new net interest income and net interest margin given a +1% (i.e. 100 bps) parallel shifts in rates.
The new net interest income and net margin following a positive 1% parallel shift in rate will be evaluated as follows
New value of the three year commercial loan = 111/100 * £750
= 832.5 MM
New value of Treasury bond = 107/100 * £150
= £160.5 MM
The New value of the 1 year time deposit = 105/100 * £500
= 525 MM
New fixed rate liabilities = 109/100 * £400
= £436
Thus, the New Net Interest Income = [832.5 MM + £160.5 MM] – [£525 MM + £436]
= £32 MM
The net interest margin = (£993 – £961)/1000
= 32/1000 * 100
= 3.2%
Part C
- Explain what Bank B can do to immunized its portfolio (i.e. what changes should be made to the balance sheet described in Table B so that DGAP is approximately equal to zero).
When the rate of interest increases, Bank B should lower the price of its coupon bond as a strategy of immunizing the firm portfolio (Angori, Aristei, and Gallo, 2019). This establishes the major two components of the portfolio: the price return and the return received from the reinvestment made. Since the weighted average duration of liabilities is greater than 1, that is 3.85
The variation of durations of individual bonds within the portfolio should have a span that extends on the far side vary of durations of individual liabilities, which suggests that the portfolio should contain individual bonds every with a period but that of the primary liability and a period bigger than that of the last liability (Wani, Haque, and Raina, 2019). The positive parallel increase in the rate of income generating assets will cause a rise in the average earning assets total while increasing the interest expenses. Other changes based on the organization balance sheet recommended include increasing the rate of the assets earning interests and lowering the percentage of the serviceable liabilities.
An additional sensible different immunization technique is period matching. Here, the period of the assets is matched with the period of the liabilities (Angori, Aristei, and Gallo, 2019). To create the match really profitable underneath dynamic interest rates, the assets and liabilities are organized so the whole convexity of assets exceeds the convexity of the liabilities (Cruz-García, de Guevara, and Maudos, 2019).
- Based on your explanation in C.I, calculate the new net interest income and net interest margin based on this strategy to immunize the portfolio of Bank B. The impact of the immunization strategy on net interest income and net interest margin can be evaluated as follows.
New value of the three year commercial loan = 111/100 * £750
= 832.5 MM
New value of Treasury bond = 107/100 * £150
= £160.5 MM
The New value of the 1 year time deposit = 105/100 * £500
= 525 MM
New fixed rate liabilities = 109/100 * £400
= £436
Thus, the New Net Interest Income = [838.5 MM + £160.5 MM] – [£525 MM + £436]
= £36 MM
The net interest margin = (£993 – £961)/1000
= 36/1000 * 100
= 3.6%
In summary, the net interest margin is the only change based on the new portfolio
References
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Wani, A.A., Haque, S.I. and Raina, S.H., 2019. Impact of Macroeconomic and Bank-Specific Indicators on Net Interest Margin: An Empirical Analysis. In Understanding the Role of Business Analytics (pp. 45-64). Springer, Singapore.