Maturity Mismatch

Updated on February 4, 2024
Article byPriya Choubey
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Maturity Mismatch?

Maturity Mismatch refers to a disbalance between the company’s short-term assets and short-term liabilities whereby the latter surpasses the former. Also known as asset-liability mismatch, the concept also indicates a situation where a hedging security’s maturity is different from that of its underlying asset.

Maturity Mismatch

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This asset-liability misalignment can be identified through a company’s balance sheet. The business may face a monetary crunch and financial inefficiency if its excess short-term liabilities result from long-term asset financing. Moreover, when the business struggles to strike a balance between short-term assets and liabilities, it raises liquidity risk concerns arising due to the firm’s inadequate use of its assets. 

Key Takeaways

  • Maturity mismatch refers to the gap between an organization’s short-term assets and short-term liabilities in a given period. Usually, the latter is elevated, thus resulting in liquidity risk.
  • Also, in terms of hedging, when the maturity period of a hedge fund or instrument differs from that of its underlying security, there is a situation of maturity misalignment.
  • Companies can prevent this mismatch by employing their short-term funding to meet their long-term liabilities or projects.
  • Also, financial institutions should efficiently manage their liquidity to curtail the risk arising from such maturity mismatching.

Maturity Mismatch Explained

The maturity mismatch can be a result of poor liquidity management in an organization. Such disparities can be gauged through a company’s balance sheet. That shows the short-term assets are not enough to meet the business’s short-term liabilities. In some cases, the companies even leverage short-term funds to acquire long-term assets. Such misalignment in hedging occurs when security tracks an underlying asset and fails to keep up with its maturity. Such a situation results in an inappropriate hedge. 

The central bank does not back these firms. Therefore, such situations can pose liquidity and interest rate risks, especially for non-banking firms, causing a cash crunch when meeting operational expenses. At times, companies tend to fund their capital expenditures or long-term projects with short-term borrowings. The project’s future profit adds short-term liabilities, raising liquidity concerns and maturity mismatch risk for the company.

Nevertheless, due to the asset-liability mismatch, financial institutions often use such a strategy to make higher marginal profits by accepting short-term deposits from customers at a low-interest rate and lending the same to long-term borrowers at elevated interest rates. Banks face a maturity mismatch when long-term loans are funded by short-term deposits, posing a financial risk. Banks may face the liquidity risk of insufficient reserves, affecting account holders’ instant money withdrawals. 

Examples

The asset-liability mismatch is a temporary problem that can be fixed with proper financial management and adjustments. Given below are some examples showcasing such misalignment and its consequences for the respective organization:

Example #1

Suppose a company has total short-term liabilities of $9,500 and short-term assets worth $11,800 at the end of its first quarter. The firm started a new project, which would take around five years to complete and generate cash flow. However, the project was funded through a short-term loan of $10,000 acquired from the bank at an interest rate of 16% per year.

Thus, the quarterly repayment liability arising from this debt was $2,900 [($10,000 + 16% of $10,000)/4]. Hence, the total short-term liabilities now amount to $12,400, which is $600 more than the total short-term assets. This gap results in a maturity mismatch.

Example #2

Let us assume that a corporate bond hedge fund with a maturity of 5 years tracks a corporate bond that is to mature in the next five years. However, the company calls the bond in 3 years, i.e., two years prior to its maturity. In this case, the corporate bond hedge fund faces a maturity misalignment with its underlying asset.

Example #3

The Silicon Valley Bank (SVB) collapse in 2021 is the most prominent example of liquidity mismanagement and maturity mismatch. SVB experienced a substantial increase in deposits, rising from $102 billion to $189.20 billion in 2021. The bank changed its strategy, thus utilizing the excess liquidity owing to the increased deposits to acquire mortgage-backed securities (MBS) worth above $80 billion with an average yield of 1.56% and ten years plus maturity. 

However, the US Federal Reserve’s decision to raise interest rates nine times in 2022 adversely impacted the value of the SVB’s MBS, especially the ones with over ten years to maturity. Now, investors can purchase long-term federal bonds at 4 to 5% amidst the COVID-19 spread. Since SVB invested in long-term MBS rather than short-term securities like Treasury bills, it became vulnerable to maturity mismatch risk.

According to the UK’s Financial Times, SVB lost around $15 billion in the MBS portfolio, which was almost equivalent to its total capital, posing a risk of insolvency if compelled to sell these bonds. It was something opposite to the SVB’s strategy of keeping excess cash in short-term mortgage bonds until 2018. Hence, the bank, which was once a startup-focused lender, ultimately collapsed due to its poor investment decisions.

Prevention

Whether in business, financial markets, or banking, maturity misalignment often raises concerns related to interest rate and liquidity risks. However, the following strategies and measures can help organizations prevent such disparities and their associated consequences:

  1. Stress Testing: Investors often face challenges in financial markets due to this asset-liability mismatch. Conducting stress tests to predict adverse market conditions and their impact on securities’ maturity helps them make relevant portfolio adjustments.
  2. Asset-Liability Management (ALM): Companies and financial institutions must avoid utilizing their short-term assets to fund long-term liabilities or projects to avoid any operational cash crunch. Effective ALM strategies help organizations clearly time cash inflows and outflows to avoid significant gaps.
  3. Liquidity Management: Financial entities require effective liquidity management strategies to prevent cash shortages, fulfill short-term obligations, and maintain adequate reserves.
  4. Interest Rate Risk Management: Organizations should keep an eye on the changes in assets and liabilities pertaining to evolving market conditions and interest rate movements to foresee and manage interest rate risk.
  5. Hedging Strategies: Various tools and techniques can save hedgers from unforeseen maturity risks. Some of these are swaps, futures contracts, forward contracts, options, caps, and floors.
  6. Diversification: The banks and other lending institutions should spread their investments across a variety of securities and assets with different maturity periods to safeguard themselves from market fluctuation risks.
  7. Robust Reporting and Communication Procedures: It is equally important to report the financial updates to stakeholders and communicate the current asset-liability mismatch situation and potential strategies to the team to ensure relevant actions and the implementation of practical measures.

Frequently Asked Questions (FAQs)

What is a contractual maturity mismatch?

A contractual maturity mismatch is a situation that is prompted by the gap or difference between the contractual cash inflows and outflows for specific periods. In terms of banking, this difference determines the expected liquidity position a financial institution needs to maintain and entertain the outflows immediately. It may even result in adjustments of the contracts and existing agreements for maturity to ensure liquidity.

What is the maturity mismatch add-on?

The liquidity coverage ratio (LCR) Rule takes into account any asset-liability mismatches affecting the company’s liquidity during the calendar month. Therefore, when the organization evaluates its net cash outflows (NCOs), the difference between its net cumulative outflow on the last day of the respective period and the outflow on the single largest or peak day is termed the maturity mismatch add-on.

What is repricing or maturity mismatch risk?

The repricing or maturity mismatch risk arises when the organization adjusts the assets and liabilities for interest rates at different amounts or times. It may lead to adverse consequences pertaining to the firm’s overall financial condition, capital, and earnings.

This has been a guide to what is Maturity Mismatch. Here, we explain the concept in detail, along with its examples and prevention. You can learn more about financing from the following articles –

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