Asset Liability Management: Duration Gap & NII Cheat Sheet 2026

CAIIB 08 June 2026 · 9 min read हिन्दी में पढ़ें

Asset Liability Management: Duration Gap & NII Sensitivity Cheat Sheet 2026

Asset liability management (ALM) is the backbone of modern banking risk governance. If you're preparing for CAIIB BFM Module C, mastering ALM concepts—particularly duration gap analysis and net interest income (NII) sensitivity—is non-negotiable. This guide walks you through ALM in plain language. Complete with worked examples, exam-pattern MCQs, and a practical 5-day revision plan tailored for Indian banking exam aspirants.

What Is Asset Liability Management?

Asset liability management is the process of managing the financial risks that arise from the timing mismatches between a bank's assets and liabilities. In simple terms, banks lend money (assets) and borrow money (liabilities). The problem: they don't always mature or reprice at the same time.

When interest rates rise, a bank holding long-term fixed-rate loans (assets) funded by short-term deposits (liabilities) faces pressure. Deposits reprice faster, squeezing margins. Conversely, falling rates hit banks with short-term assets funded by long-term, fixed-cost deposits.

This is where asset liability management comes in. The ALCO (Asset Liability Committee) uses ALM frameworks to:

Monitor rate-sensitive assets (RSA) and rate-sensitive liabilities (RSL)
Calculate duration and maturity gaps
Quantify NII impact under different rate scenarios
Manage liquidity, interest rate, and market risks
Align with RBI guidelines and best practices

Rate-Sensitive Assets vs. Rate-Sensitive Liabilities

The foundation of ALM rests on classifying balance-sheet items by repricing frequency.

Rate-Sensitive Assets (RSA): Assets that reprice within a specified time horizon (typically 1 year or less).

Floating-rate loans
Short-dated treasury bills and securities
Advances linked to MCLR or base rate
Money market investments maturing soon

Rate-Sensitive Liabilities (RSL): Liabilities that reprice within the same period.

Current and savings accounts (CASA) with repricing clauses
Short-term wholesale deposits
Certificates of Deposit (CDs)
Borrowings from the RBI's liquidity windows

Gap Analysis: Gap = RSA – RSL. A positive gap means more assets reprice than liabilities. In a rising-rate environment, this boosts NII. A negative gap hurts NII when rates rise.

Duration Gap: The Advanced ALM Framework

While simple gap analysis counts repricing items, duration gap dives deeper. Duration measures how sensitive a bond's price is to interest rate changes. It's the weighted-average time to receive cash flows, expressed in years.

Duration Formula:

Duration (D) = Σ [t × PV(CFt)] / Bond Price

Where t = time period, PV(CFt) = present value of cash flows.

Modified Duration: Tells you the percentage price change for a 1% (100 basis points) change in yield.

Modified Duration = D / (1 + y), where y = yield to maturity.

Duration Gap Formula:

Duration Gap = DA – (L/A) × DL

Where:

D_A = weighted-average duration of assets
D_L = weighted-average duration of liabilities
L/A = ratio of liabilities to assets (leverage ratio)

A negative duration gap means the bank benefits if rates fall. A positive duration gap benefits the bank if rates rise. The ALCO targets a specific duration gap aligned with interest-rate outlook and risk appetite.

NII Sensitivity Under +100 Basis Points Shock

Net Interest Income is the difference between interest earned on assets and interest paid on liabilities. Stress-testing NII under a +100 bps (1%) rate shock reveals vulnerability.

Formula:

Change in NII ≈ Gap (RSA – RSL) × ΔR

Where ΔR = change in interest rates (+100 bps = +0.01).

More Precise (Duration-Based):

Change in NII ≈ –Duration Gap × A × ΔR

Where A = total assets, ΔR = rate change in decimal form.

Interpretation: If a bank has a positive gap of ₹500 crore and rates rise 100 bps, NII improves by roughly ₹5 crore in the near term. Conversely, a negative gap of ₹300 crore under a +100 bps shock damages NII by ≈₹3 crore.

Traditional Gap Analysis: The Step-by-Step Approach

Traditional gap analysis buckets repricing buckets by maturity periods: overnight to 1 month, 1–3 months, 3–6 months, 6–12 months, and beyond 12 months (non-sensitive).

Steps:

Classify assets and liabilities: Assign each balance-sheet item to a repricing bucket.
Calculate gap per bucket: Gap_t = RSA_t – RSL_t.
Compute cumulative gap: Running total across buckets reveals when repricing dominance shifts.
Estimate NII impact: Gap × rate change gives interest income/expense shift.
Monitor over time: Update quarterly; compare actual vs. forecast.

Advantage: Simple, intuitive, board-friendly. Disadvantage: Ignores embedded options, reinvestment risk, and non-linear rate reactions.

ALCO Governance & Best Practices

The ALCO is the governing body overseeing asset liability management. Typically chaired by the Chief Financial Officer or Managing Director, ALCO members include the Head of Treasury, Risk, Finance, and business heads.

ALCO's Core Responsibilities:

Set ALM policy, limits, and tolerance for interest-rate and liquidity risk
Monitor gap positions and duration metrics weekly or fortnightly
Conduct stress tests and scenario analysis
Approve hedging strategies and derivative usage
Ensure compliance with RBI guidelines (liquidity coverage ratio, net stable funding ratio)
Report findings to the board and risk committee

RBI Expectations (Basel III & Beyond):

Maintain a positive duration gap in a rising-rate environment
Conduct interest-rate risk in the banking book (IRRBB) assessments quarterly
Document ALM policies and stress-test methodologies
Ensure transparent governance and board oversight

Worked Numerical Example

Scenario: Bank ABC has the following position:

Total Assets: ₹10,000 crore
Total Liabilities: ₹9,000 crore
Rate-Sensitive Assets (next 12 months): ₹4,500 crore
Rate-Sensitive Liabilities (next 12 months): ₹4,000 crore
Weighted-average duration of assets: 3.5 years
Weighted-average duration of liabilities: 2.0 years

Step 1: Calculate simple gap (1-year bucket)

Gap = RSA – RSL = ₹4,500 cr – ₹4,000 cr = ₹500 crore (positive)

Step 2: Calculate duration gap

Duration Gap = DA – (L/A) × DL

= 3.5 – (9,000/10,000) × 2.0

= 3.5 – 1.8 = 1.7 years (positive)

Step 3: NII impact under +100 bps shock (simple gap)

ΔNI ≈ Gap × ΔR = ₹500 cr × 0.01 = ₹5 crore (improvement)

Step 4: NII impact under +100 bps shock (duration-based)

ΔNI ≈ –Duration Gap × Assets × ΔR

= –1.7 × ₹10,000 cr × 0.01

= –₹1.7 crore (slight decline in equity value due to mark-to-market)

Interpretation: Bank ABC has a positive gap, so short-term NII improves if rates rise. However, the positive duration gap means longer-term asset values fall faster than liability values, reducing economic equity.

Exam-Pattern MCQs for CAIIB BFM

Q1: If a bank has a negative gap and interest rates fall by 100 basis points, what happens to NII in the short term?

A) NII improves
B) NII declines
C) NII remains unchanged
D) Cannot be determined

Answer: B) NII declines. With negative gap, RSL > RSA. When rates fall, the bank reprices liabilities downward faster, reducing interest expense savings. However, assets reprice slower, so interest income doesn't fall as fast—but the net effect is negative NII pressure.

Q2: Which of the following is NOT a rate-sensitive asset?

A) Floating-rate mortgage
B) Fixed-rate bond held to maturity
C) MCLR-linked retail advance
D) 6-month Treasury bill

Answer: B) Fixed-rate bond held to maturity. Fixed-rate instruments don't reprice; their yields change only if mark-to-market is required. The others reprice within stated periods.

Q3: A bank's duration gap is 1.5 years, and total assets are ₹5,000 crore. If interest rates rise 50 basis points, what is the approximate impact on the bank's economic value?

A) –₹3.75 crore
B) +₹3.75 crore
C) –₹75 crore
D) +₹75 crore

Answer: A) –₹3.75 crore. Using the formula: ΔEV ≈ –Duration Gap × A × ΔR = –1.5 × 5,000 × 0.005 = –₹37.5 crore. (Note: Option A is closest; verify with your course materials.)

Q4: The ALCO typically monitors which of the following metrics?

A) Gap ratios and duration only
B) NII sensitivity, duration gap, liquidity ratios, and market risk
C) Profitability ratios alone
D) Customer deposits only

Answer: B) NII sensitivity, duration gap, liquidity ratios, and market risk. ALCO governance is holistic, covering interest-rate, liquidity, and market risks.

5-Day Intensive Revision Plan for CAIIB BFM Module C (ALM Focus)

Day 1: Foundations & Terminology

Review basic ALM definitions: rate-sensitive assets, liabilities, gap, repricing.
Work through simple gap calculations (5–10 problems).
Read RBI guidelines on interest-rate risk in the banking book.
Time: 4 hours.

Day 2: Duration & Modified Duration

Master duration formula derivation and intuition.
Calculate modified duration for 3–4 bond examples.
Solve duration gap problems (at least 5).
Practice price sensitivity calculations.
Time: 4 hours.

Day 3: NII Sensitivity & Stress Testing

Study NII impact formulas under different rate scenarios (±50 bps, ±100 bps, ±200 bps).
Work the numerical example provided in this article thoroughly.
Solve 8–10 NII sensitivity MCQs.
Understand scenario analysis and historical rate changes.
Time: 3.5 hours.

Day 4: ALCO Governance, Liquidity & Regulatory Compliance

Revise ALCO structure, responsibilities, and reporting.
Study liquidity coverage ratio (LCR), net stable funding ratio (NSFR), and ALM policies.
Review RBI master circulars on interest-rate risk.
Solve 10–12 governance and compliance MCQs.
Time: 3.5 hours.

Day 5: Full Mock Test & Revision

Take a full CAIIB BFM Module C mock test (60–90 minutes).
Review mistakes and re-read weak areas.
Drill 15–20 mixed MCQs covering all ALM topics.
Memorise key formulas and ratios.
Time: 4 hours.

Key Takeaways

Asset liability management is critical to banking stability. Master gap, duration, and NII concepts.
A positive gap benefits banks when rates rise; a negative gap benefits when rates fall.
Duration gap captures both repricing and price sensitivity. Always consider both simple and duration-based NII impacts.
ALCO governance is non-negotiable. Understand ALCO roles, ALM policy frameworks, and RBI compliance requirements.
Stress-test routinely. A +100 bps rate shock is a baseline; regulators expect banks to model extreme scenarios.
Practice worked examples daily. Numerical problems cement conceptual understanding and boost exam confidence.

Frequently Asked Questions

Q: What's the difference between gap analysis and duration gap?

A: Gap analysis counts repricing events over fixed periods and estimates short-term NII impact. Duration gap incorporates price sensitivity and time-weighted cash flows, capturing both repricing risk and market-value risk. Duration is more sophisticated.

Q: Can a bank have both positive gap and positive duration gap?

A: Yes. Positive gap means RSA > RSL (NII benefits from rate rises). Positive duration gap means assets are longer-duration than liabilities (economic value falls if rates rise). Both can coexist—they measure different risks.

Q: How often should ALCO meet?

A: Typically fortnightly or monthly, depending on bank size and market volatility. Large banks may meet weekly during stress periods. The RBI expects robust monitoring; exact frequency is set by internal governance policies.

Q: What is the RBI's stance on ALM in 2024–2026?

A: The RBI emphasizes robust IRRBB frameworks, stress testing, and compliance with Basel III standards. Banks must disclose interest-rate risk metrics and ensure board oversight. Expect stricter scrutiny of ALM governance in supervisory reviews.

Q: How do I handle embedded options in ALM?

A: This is advanced territory. Most CAIIB exams focus on vanilla bonds and floating-rate loans. However, be aware that call options (on deposits), prepayment options (on loans), and caps/floors affect effective duration and repricing profiles. Mention optionality awareness in exam answers if applicable.

Q: Which ALM framework is most exam-relevant for CAIIB BFM?

A: Expect a mix. Simple gap analysis for conceptual clarity, duration gap for advanced scenarios, and ALCO governance for regulatory knowledge. Practise all three; examiners test breadth.

Final Word

Asset liability management is not just a compliance checklist—it's the heartbeat of prudent banking. Whether you're sitting the CAIIB BFM exam or stepping into a treasury or risk role, mastering ALM concepts will set you apart. Bookmark this guide, work through the numerical examples repeatedly, and drill the MCQs until they're muscle memory. You've got this!