Explain the available funds gap and work out its value.
The idea
The available funds gap measures how much a bank must raise from borrowed, non-core sources. Funds needed are the projected loans (current balance plus expected growth) plus the reserves and liquid assets the bank wants to hold, written Needed. Core deposits are the stable, rate-insensitive balances of small retail and local business customers, and their total is written Core. Large negotiable CDs, brokered funds and other volatile liabilities do not count as core. Gap = Needed − Core. A positive gap means the bank must borrow or sell liquid assets. A negative gap means surplus funds to invest. The usual errors are reversing the sign, leaving out the liquidity buffer or the loan growth, and counting volatile deposits as core. On the exam, project each component to the same date before subtracting, and treat the result as the amount to be funded in the market.
Formulas
Available funds gap
Gap = Needed − Core
- Needed
- projected loans including growth, plus the reserves and liquid assets to be held
- Core
- projected core deposits: stable, rate-insensitive retail and local business balances
Positive means the bank must borrow or sell liquid assets. Project both to the same date, include the liquidity buffer and loan growth, and never count large CDs or brokered funds as core.
A practice question
The available funds gap is defined as the funds a bank needs (loans and other assets to be financed) less the funds supplied by core deposits. A positive gap means that:
- Core deposits exceed funding needs, so the bank has surplus funds to invest.Why not: Reverses the sign; a positive gap means needs exceed core deposits.
- The bank must raise the difference from borrowed sources or by selling liquid assets. - correct
- The bank is insolvent because loans exceed its capital.Why not: Confuses a funding gap with insolvency; the gap compares needs with core deposits, not with capital.
- The bank should reduce its holdings of liquid assets to cover the gap.Why not: Liquid assets are a source of cover for the gap, not something to be reduced; reducing the buffer would widen it.
Funds needed minus core deposits is positive when core deposits fall short. The shortfall has to come from non-core borrowing or from converting liquid assets into cash.
A harder one
A bank's available funds gap is currently USD 130 million. Over the next quarter loans are expected to rise by USD 55 million and core deposits to fall by USD 20 million, with all other items unchanged. Closest to the new gap, in USD millions?
- 165Why not: Treats the fall in core deposits as a rise (130 + 55 - 20); a deposit decline widens the gap.
- 55Why not: Subtracts both changes (130 - 55 - 20); loan growth increases funding needs.
- 205 - correct
- 185Why not: Adds the loan growth but ignores the decline in core deposits.
Loan growth raises funds needed by 55 and the deposit decline lowers funds supplied by 20, so the gap widens by 75: 130 + 55 + 20 = USD 205 million.
The hardest tier
A bank has loans of USD 1,200 million expected to grow 8%, and core deposits of USD 900 million expected to fall 3%. It wants reserves and liquid assets equal to 12% of projected core deposits. With available funds gap = projected loans + reserves and liquid assets - projected core deposits, closest to the gap, in USD millions?
- 423Why not: Omits the reserves and liquid assets requirement (1,296 - 873).
- 480Why not: Treats the 3% change in deposits as a rise to 927, which understates the gap.
- 579Why not: Applies the 12% liquidity requirement to projected loans instead of to core deposits.
- 528 - correct
Projected loans = 1,200 x 1.08 = 1,296. Projected core deposits = 900 x 0.97 = 873. Reserves and liquid assets = 0.12 x 873 = 104.76. Gap = 1,296 + 104.76 - 873 = 527.76, about USD 528 million.
In the app: 6 practice questions on this outcome, spaced review that brings it back before you forget it.
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