In finance, anasset–liability mismatch occurs when the financial terms of an institution'sassets andliabilities do not correspond. Several types of mismatches are possible. An asset-liability mismatch presents a material risk at institutions with significant debt exposure, such as banks or sovereign governments. A significant mismatch may lead to insolvency or illiquidity, which can cause financial failure. Such risks were among the principal causes of economic crises such as the1980s Latin American Debt Crisis, the2007 Subprime Mortgage Crisis, theU.S. Savings and Loan Crisis, and thecollapse of Silicon Valley Bank in 2023.
For example, a bank that borrows funds inU.S. dollars and lends inRussian rubles would have a significantcurrency mismatch: if the value of the ruble were to fall relative to the dollar, then the bank would incur a financial loss. In extreme cases, such changes in the value of the assets and liabilities could lead tobankruptcy,liquidity crises, orbalance-of-payment crises.
According to Anne O. Krueger of theIMF, the combination offixed exchange rates and unsustainable debt burdens can amplify the impact of currency mismatch risk.[1] Krueger proposes sound economic policies of reducing public debt and managing capital flows as ways of mitigating these crises.
According to research fromBank of International Settlements, the risk presented by aggregate currency matches (at the national level) may be mitigated by stronger foreign exchange positions by the government sector.[2] Higher forex reserves and less foreign currency-denominated debt are two measures of capital strength which may be useful in this regard.
A bank could also have substantial long-term assets (such asfixed-rate mortgages) funded by short-term liabilities, such asdeposits. If the liabilities become due before the assets, then the bank may be unable to satisfy its obligations. As a result, it may be forced to liquidate some of its assets (perhaps at a loss) or raise additional capital (which may be dilutive or otherwise costly).
As pointed out by research from theUniversity of Chicago, the liquidity mismatch caused between loans and deposits may be addressed bydeposit insurance, such as that provided by theFDIC.[3]
Duration mismatch is an indication of a firm with liquidity problems, and it may be measured using thequick ratio,acid test, or similar accounting metrics. This is sometimes called amaturity mismatch orliquidity mismatch, which can be measured by theduration gap.
Researchers analyzed the impact of liquidity mismatches in the years surrounding the 2007 Subprime mortgage crisis.[4] They found that firms with more significant liquidity mismatch risk tended to:
Aninterest rate mismatch occurs when a bank borrows at oneinterest rate but lends at another. For example, a bank might borrow money by issuingfloating interest rate bonds, but lend money withfixed-rate mortgages. If interest rates rise, the bank must increase the interest it pays to its bondholders, even though the interest it earns on its mortgages has not increased. This discrepancy can produce negative cash flows, which are financially unsustainable over the long term.
Interest rate mismatch was identified as the primary cause of the U.S. Saving and Loan Crisis in the 1980s.[5][6] While interest rates rose as part of restrictive monetary policy, financial regulations had set limits on interest rates that could be offered in depository accounts. As a result, clients withdrew funds from depository institutions, creating immense financial pressure when combined with declining real estate prices.
Mismatches are handled byasset liability management. Solutions broadly include risk reduction, mitigation, orhedging.
Duration and currency mismatches were pointed out as key causes of the1997 Asian Financial Crisis.[7]
Asset–liability mismatches are important to insurance companies and various pension plans, which may have long-term liabilities (promises to pay the insured or pension plan participants) that must be backed by assets. Choosing assets that are appropriately matched to their financial obligations is therefore an important part of their long-term strategy.
Few companies or financial institutions have perfect matches between their assets and liabilities. In particular, the mismatch between the maturities of banks' deposits and loans makes banks susceptible tobank runs. On the other hand, a 'controlled' mismatch, such as between short-term deposits and somewhat longer-term, higher-interest loans to customers is central to many financial institutions' business model.