Maturity Gap

For your birthday, you want tickets to the opera and a wine tasting tour. Your friends suggest a farting contest and a cartoon marathon. Maturity gap.

The term also comes up in financial planning. "Maturity gap" specifically comes up in relation to the internal finances of banks and other similar institutions.

Debt instruments, like bonds or loans, have two main components: maturity and rate. Maturity measures the amount of time a party has to pay back a loan. The rate measures how much interest they will pay.

So...if you have a 30-year mortgage at 6%, the maturity is 30 years and the interest rate is 6%.

The maturity gap tallies up the assets and liabilities for a bank and compares the rates for various maturities. The risk comes in if the interest rates for a bank's liabilities are higher than the rates it earns from its assets.

You run a bank. You're borrowing money at 8% and lending it out at 6%. You're not going to have a bank very much longer.

You want to borrow money relatively cheaply and then lend it out at a higher rate. That's a bank's basic business model. Sometimes it's hard to see how well this is working though. That's because various maturities of debt have different rate levels. Longer-term debt almost always comes with a higher rate...which makes sense, since you're locking your money up for a longer period of time. So a one-year bond might pay only 2%, while a 10-year bond issued by the same company might carry a rate of 6%. Higher rates for longer maturities.

If a bank borrows short-term money at 2% and lends it out in long-term mortgages at 6%, it might seem like it's doing its job. Borrowing at 2% and lending out at 6%...setting itself up for a profit. But there's a mismatch there. The bank has to pay those short-term debts very soon. Meanwhile, it has to wait a long time to get back the money it loaned out on the 30-year mortgage. It's a kind of an apples-to-oranges, kiwis-to-watermelon situation.

So to really clock what's going on, banks look to the maturity gap. This process involves grouping the various assets and liabilities into maturity buckets. Short-term stuff with short-term stuff...long-term stuff with long-term stuff. Then the rates of the assets are compared to the rates of the liabilities within the same intervals. That comparison provides a measure of the maturity gap.