Interest rate risk in the U.S. banking sector

Abstract

We study interest rate risk at U.S. banks by measuring the impact of interest rate changes on banks’ economic value of equity (EVE) and earnings. We find that a 100 bps increase in interest rates reduces the EVE of the aggregate banking sector in the range of 8% to 18%, depending on the composition of banks’ balance sheets, and increases banks’ net interest margin by 13 bps on average. In addition, we find that small banks have higher interest rate sensitivities than large banks. During the COVID-19 pandemic period, U.S. banks became more exposed to interest rate risk due to an increase in the share of long-term securities with low interest rates in their asset composition, contributing to a 40% decline in EVE when the Federal Reserve raised interest rates in 2022. Overall, our results show that U.S. banks are exposed to substantial interest rate risk.