Banking Practice Exam

In the context of bank asset-liability management, a negative GAP indicates that a bank has more liabilities than assets that are sensitive to interest rate changes. This means that when interest rates rise, the bank's liabilities reprice and become more expensive at a faster pace than its assets do.

As interest rates increase, the interest income generated from the bank's assets (like loans and securities) will likely decrease because these assets are less sensitive to rate changes than the bank's liabilities. Concurrently, the interest expense on the bank's liabilities will increase significantly, reflecting the higher rates on deposits and other borrowed funds.

Since the increase in interest expense outpaces any increase in interest income from assets, the net interest income, which is the difference between interest income and interest expense, is expected to decrease. This scenario outlines the critical dynamics of a negative GAP in the context of rising interest rates.