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LIQUIDITY GAP CALCULATIONS

There are liquidity gaps and marginal gaps, static and dynamic gaps, and other details that need to be considered for projecting liquidity gaps. The most common liquidity gap profiles are static gaps calculated by projecting the balances of existing assets and liabilities. Dynamic gaps include in the projection the new loans or debts as projected from today.

Static Liquidity Gaps

Static liquidity gaps are differences of projected future balances of existing assets and liabilities. Incremental, or marginal gaps, are differences in variations between two adjacent time points. Both simple and marginal gaps are calculated. The cumulated value over time of the marginal gaps is equal to the gap between the current outstanding balances of assets and liabilities. Table 22.1 is an example of a gap time profile.

TABLE 22.1 Time profiles of outstanding assets and liabilities and of liquidity gaps

 Dotes 1 2 3 4 5 6 Assets 1000 900 700 650 500 300 Liabilities 1000 800 500 400 350 100 Gap8 0 100 200 250 150 200 Assets amortization -100 -200 -50 -150 -200 Liabilities amortization -200 -300 -100 -50 -250 Marginal gap 100 100 50 -100 50 Cumulative marginal gap 100 200 250 150 200

Calculated as the difference between assets and liabilities. A positive gap is a deficit that requires funding. A negative gap is an excess of resources to be invested.

Calculated as the algebraic variation of assets minus the algebraic variation of liabilities between t and t - I .With this convention, a positive gap is an outflow, and a negative gap is an inflow. The cumulative marginal gaps are identical to the gaps calculated with the outstanding balances of assets and liabilities.

FIGURE 22.2 Time profile of liquidity gaps

FIGURE 22.3 Time profile of marginal liquidity gaps

In Table 22.1, assets amortize slower than liabilities. Therefore, the inflows from repayments of assets are less than the outflows used to repay the debts, calculated with the outstanding balances of asset and liabilities. A deficit cumulates from one period to the other, except in period 5. Figures 22.2 and 22.3 show cumulative and marginal gap time profiles.

Marginal, or incremental, gaps are the differences between the variations of assets and liabilities during a given period (Figure 22.2). A positive marginal gap means that the algebraic variation of assets exceeds the algebraic variation of liabilities: It is an inflow. A negative marginal gap means that assets amortize at a slower pace than liabilities at that period: It is an outflow[1].

The marginal gaps represent the new funds required, or the new excess funds of the period available for investing. The implicit assumption is that all previous gaps have been financed or invested up to some management horizon. Then, a new marginal gap represents the new financing required or the new investment of lending required for closing the liquidity gaps assuming previous lending/borrowing contracted in previous time points stay in place. The new funding, say between the dates 2 and 3, is not the cumulated deficit between dates 1 and 3, or 200, because the debt contracted at date 2, for example 100, does not necessarily amortize at date 3. If the debt is still outstanding at 3, the deficit at date 3 is only 100. This is the rationale for using marginal gaps. They represent the amounts to raise or invest over a given horizon, and for which new decisions are necessary.

The cumulated gaps are easier to interpret, however. Such cumulative gaps represent only the cumulated needs for funds required at all dates, not the new financing or investment at each date (Figure 22.3). This would be the case only when debts or investment of previous periods would amortize at the next time point.

Table 22.2 shows a sample liquidity gap profile from annual report of KBC, 2006. The time buckets are quite large in this sample table. Most tools provide gaps over more frequent time points, at least monthly for up to 1 to 3 years. The next diagram (Figure 22.4) shows the output of a standard ALM software. The top part shows how asset and liabilities amortize through time by monthly steps. The assets are shown on the up section (dark grey area) of the j-axis and time is along the x-axis. Liabilities appear in the down section as a shaded area. The lines show the average interest rates of assets and of liabilities respectively. The liquidity gap time profile is the difference between assets and liabilities. Figure 22.5 shows the time profile of

TABLE 22.2 Sample liquidity gap time profile

*Excluding derivatives

Source: KBC Annual Report,2006

FIGURE 22.4 Time profiles of assets and liabilities

FIGURE 22.5 Time profile of liquidity gap and limits

the liquidity gap, magnified from Figure 22.4. Liquidity gaps are subject to limits. The gap limit is the horizontal line.

Note that software providers embed a number of useful functionalities in their products. For example, it is possible to drill down in any one gap for any date for finding out which transactions contribute to the gap. Any spike in the gap profile can be allocated to the corresponding transactions, which make such tools essential for balance sheet management.

• [1] For instance, if the amortization of assets is 3, and that of liabilities is 5, the algebraic marginal gap, as defined above, is -3 - (-5) = + 2, and it is an outflow. Sometimes the gaps are calculated as the opposite difference. It is important to keep a clear convention, so that the figures can be easily interpreted.

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