Stabilizing the book value of net interest income
This can be done for a 1-year time horizon, with the appropriate duration gap measure:
DGAP* MVRSA(1- DRSA) - MVRSL(1- DRSL) where
MVRSA = cumulative market value of RSAs, MVRSL = cumulative market value of RSLs, DRSA = composite duration of RSAs for the given time horizon; equal to the sum of the products of each asset’s duration with the relative share of its total asset market value, and DRSL = composite duration of RSLs for the given time horizon; equal to the sum of the products of each liability’s duration with the relative share of its total liability market value.
If DGAP* is positive, the bank’s net interest income will decrease when interest rates decrease, and increase when rates increase.
If DGAP* is negative, the relationship is reversed.
Only when DGAP* equals zero is interest rate risk eliminated.
Banks can use duration analysis to stabilize a number of different variables reflecting bank performance.