What Is a Maturity Mismatch?Maturity mismatch is a term used to describe situations when there's a disconnect between a company's short-term assets and its short-term liabilities—specifically more of the latter than the former. Maturity mismatches can also occur when a hedging instrument and the underlying asset's maturities are misaligned. Show
A maturity mismatch may also be referred to as an asset-liability mismatch. Key Takeaways
Understanding a Maturity MismatchThe term maturity mismatch commonly alludes to situations involving a company's balance sheet. A business cannot meet its financial obligations if its short-term liabilities outweigh its short-term assets and will likely run into problems, too, if its long-term assets are funded by short-term liabilities. Maturity mismatches can shed light on a company's liquidity, as they show how it organizes the maturity of its assets and liabilities. They can also signify that the company is not using its assets efficiently, which could give rise to a squeeze in liquidity. Mismatches can take place in hedging as well. This happens when the maturity of an underlying asset doesn't match the hedging instrument, thus creating an imperfect hedge. For example, a mismatch occurs when the underlying bond in a one-year bond future matures in three months. Preventing Maturity MismatchesLoan or liability maturity schedules must be monitored closely by a company's financial officers or treasurers. As much as it is prudent, they will attempt to match expected cash flows with future payment obligations for loans, leases, and pension liabilities. A bank will not take on too much in short-term funding—liabilities to depositors—to fund long-term mortgage loans or bank assets. Similarly, an insurance company will not invest in too many short-term fixed income securities to meet future payouts, and a city or state treasurer's office will not invest in too many short-term securities to prepare for long-term pension payments. In a broader sense, a non-financial company also carries maturity mismatch risk if, for example, it borrows a short-term loan for a project or capital expenditure (CapEx) that will not produce cash flows until a later year. An infrastructure contractor that takes out a loan with a five-year maturity will create maturity mismatch risk if the cash flows from the project begin in 10 years. Special ConsiderationsExact matching of maturities—such as cash flows from assets to meet liabilities as they come due—is sometimes not practical nor necessarily desirable. In the case of a bank that requires spread for profitability, borrowing short-term from depositors, and lending long-term at a higher interest rate generates a net interest margin for profits. Financial companies can benefit from maturity mismatches when they borrow from short-term depositors and lend long-term at higher interest rates as this should lead to higher profit margins. Example of Maturity MismatchCompanies that borrow heavily must be mindful of their maturity schedules, as illustrated in the following example. Faced with the near-term maturities of two senior secured second lien notes in 2018 and 2020, struggling home-builder K. Hovnanian Enterprises issued senior secured notes in 2017. These notes have maturities in 2022 and 2024 to pay off the notes with the shorter maturities. This action was deemed necessary because the company recognized it would not generate sufficient cash to meet the 2018 and 2020 liabilities and had to resort to this to alleviate the issue arising from the initial maturity mismatch. Video Transcriptthe asset liability time mismatch that banks face comes down to really this factor of time. So we're looking at the difference in time for assets and liabilities. We see that banks, when it comes to their liabilities, these are typically withdrawn in a very short period of time or otherwise, they're fairly short term liabilities. Whereas if we're looking at banks assets, these tend to be more long term. So when you think about the loans that they give to their customers, these are typically going to be paid out over a very long term, sometimes several years or even decades. So it comes down to this difference in long term versus short term that gives them this time mismatch between their assets and liabilities. What is asset/liability mismatch in banks?What is asset liability mismatch? To put it in simple terms, mismatch occurs when the tenure of maturing loans (which are on the assets side of the balance sheet of a bank) do not match the tenure of the sources of funds on the liabilities side.
What is meant by asset/liability time mismatch?This asset-liability time mismatch—the ability for customers to withdraw bank's liabilities in the short term while customers repay its assets in the long term—can cause severe problems for a bank.
Why banks experience a mismatch between assets and liabilities?In addition to loans, security portfolios also compose bank assets. Banks must manage interest rate risk, which can lead to a mismatch of assets and liabilities. Volatile interest rates and the abolition of Regulation Q, which capped the rate at which banks could pay depositors, contributed to this problem.
How do banks match assets and liabilities?Asset/liability management is also used in banking. A bank must pay interest on deposits and also charge a rate of interest on loans. To manage these two variables, bankers track the net interest margin or the difference between the interest paid on deposits and interest earned on loans.
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What is the asset/liability time mismatch that all banks face?
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