Negative gap

A negative gap describes the situation in which a financial institution's interest-sensitive liabilities exceed the institution's interest-sensitive assets. 

In a similar manner, it is possible to describe the negative gap as the opposite of a positive gap, namely, a situation in which a financial institution’s interest-sensitive assets exceed its liabilities. Ultimately, the question is whether or not the financial institution can meet its financial obligations and cover the interest cost of its liabilities.

There is also another type of interest gap which is called a zero duration gap. It takes place when there is no positive gap or negative gap and a firm is protected against interest rate movements.

It is possible to calculate the exact size of the negative gap by using a simple formula:

interest-bearing assets – interest-bearing liabilities = negative gap

Due to the fact that interest rates change, it is important to keep in mind that depending on the change, also the size of the negative gap will change. In situations where the interest rate increases, the liabilities will be repriced at a higher cost, leading to an increase in losses. 

Irrespective of whether they are positive or negative, interest rate gaps can serve as productive indicators for estimating the impact of interest rate changes on the net interest income.