How Interest Rates Affect U.S. Commercial Banks

Abstract

This article explores how interest rate fluctuations impact U.S. commercial banks, focusing on the 2022–2023 period when the Federal Reserve sharply raised the federal funds rate to combat inflation. This article finds that rising rates widened net interest margins, boosting banks’ net interest income (NII). However, higher rates also brought challenges. Exemplified by Silicon Valley Bank (SVB)’s collapse, this article notes that the market value of banks’ long-term fixed-rate assets plummeted, leading to widespread unrealized losses. Moreover, deposit flows shifted, with large banks gaining deposits post-SVB failure, while regional and mid-size banks faced outflows and had to raise deposit rates to compete. By early 2023, funding costs rose and loan growth slowed, pressuring NII. The article further examines banks’ interest rate risk management strategies, including asset-liability management (ALM), financial derivatives, and regulatory stress tests, noting gaps in pre-2023 stress scenarios. It highlights that effective governance and diversified operations can mitigate risks, while poor risk management led to failure. The 2022–2023 experience also underscores that prudent rate risk management turns rate hikes into opportunities, while mismanagement increases vulnerability.