Question ''A commercial bank takes in short-term deposits and the uses those funds to make longer term loans. As such, the duration of the bank’s assets tends to be longer than the duration of the bank’s liabilities. What will happen when interest rates rise? ‘’ Now the obvious answer is - Assets will decrease in value more than the decrease in liabilities because the asset duration is more than liability duration. But my question is how come the duration of asset portfolio with short term deposits be more than the duration of long term liablilities? Please help… The more i try to understand duration, more it gets confusing!!
I think the confusion is which is a liability and which is an asset… For the bank…assets are the longer term loans that they have given out…and liabilities are the deposits they are holding…hence, the assets have longer duration, liabilities have shorter ones…thats how I look at it. Hope that clears up your issue.
It clarifies…Need to think from banks balance sheet perspective. Thanks.