Page 44 - DMGT512_FINANCIAL_INSTITUTIONS_AND_SERVICES

Unit 3: Financial Institutions

A positive gap (asset sensitive bank) is an implicit bet that interest rates will increase; a negative Notes
one (liability sensitive bank) that they will fall. When the gap is zero, the bank has no exposure
to income risk: a change in interest rates will not change the bank's income. The relation for the
expected change in interest margin is given by:
E( IM) = GapE ( i)

Gap ratio: defined as RSA/RSL is frequently utilised to evaluate the time-path of a bank Gap or
to make comparisons with the Gap of other banks.
To reduce the gap to zero, the bank of the example can sell 10 mln of short-term assets and buy 10
mln of long-term assets. Alternatively, it can operate in derivatives, both symmetric and
asymmetric. In the first case, it can buy futures or it can sell interest rate swaps or FRAs in order to
transform 10 mln of its floating rate assets into fixed rate assets, as we shall show later on.

3.8 Summary

Financial institutions can be defined as private or public organizations that, broadly
speaking, act as a channel between savers and borrowers of funds.
Two main types of financial institutions with increasingly blurred dividing line are
depository banks and credit unions and non-depository insurance companies and mutual
funds.
The two main reasons for the existence of financial institutions are economic development
and financial stability.
Financial stability as a reason for the existence of financial institutions leads to its role in
economic development again.
A commercial bank is a type of financial intermediary that provides checking accounts,
savings accounts, and money market accounts and that accepts time deposits Commercial
banks.
Private sector banks emerged in India after liberalization.
Commercial banks had to keep up with the progressive offers made by their private and
foreign counterparts.
Thus Indian commercial banks started making financial innovations.
Some innovations are driven by broader technological advances.

Some are purely a reaction to a profit or business opportunity.
There are also innovations which are the result of regulation or other government policy
actions.

For smooth functioning, commercial banks have to manage their assets and liabilities.
3.9 Keywords

Credit Cards: A card that may be used repeatedly to borrow money or buy products and services
on credit.

Debit Cards: A card which allows customers to access their funds immediately, electronically.
Gap Analysis: Gap analysis estimates the net effect on income of interest rate changes.

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