Daily Management Review

Regulators Warn that Better Defense Against Rates Shocks needed by U.S. Banks


09/02/2016




Regulators Warn that Better Defense Against Rates Shocks needed by U.S. Banks
U.S. banks have been prompted to shift their balance sheets in ways that put them at risk if rates suddenly spike, regulators are warning due to years of stubbornly low interest rates and expectations they will remain low for years to come.
 
Long-term loans that promise higher yields than the miniscule returns on short-term debt were stocked up by the banks. Such loans were often tied to real estate and property development.
 
However, higher interest rates could trap banks in a corner, forcing them to pay more to cover their immediate financing needs than they earn on their loans due to the widening gap between long-term loans and mostly short-term funding.
 
Martin Gruenberg, chairman of the Federal Deposit Insurance Corporation(FDIC), said this week that the dynamic "raises the interest rate risk issue that we are very focused on."
 
Federal Reserve has been sending signals that it will lift rates only gradually and spread the increases over a long period and the banks are broadly positioned according to the signals.
 
Regulators say that short-term rates could also climb in a weakening economy and central banks can move quickly too, even if that now appears unlikely.
 
"(There) could be impacts on the economy apart from monetary policy," Gruenberg said.
 
Banks could be tested by a surprise upheaval like the recent Brexit vote, says the Office of Financial Research, an independent watchdog within the Treasury Department.
 
"Investors (are) open to heavy losses from large jumps in interest rates, whether from surprises in the Federal Reserve's monetary policy or other shocks," the OFR wrote in a recent report.
 
Interest rate risk among market perils is also counted by the Office of the Comptroller of the Currency.
 
Banks might already be too exposed to long-term, commercial real estate that could sour and hit the broader economy, Boston Fed president Eric Rosengren warned this week.
 
The most prominent U.S. example how a spike in short-term rates could wreak havoc in the financial industry is the savings and loan crisis of the 1980s and the early 1990s.
 
Many lenders switched to riskier credits to keep up with a spike in costs when the Fed pushed its benchmark rate above 19 percent in the early 1980s. Those loans later soured and contributed to the collapse of hundreds of lenders.
 
When then-Fed Chairman Ben Bernanke suggested that the central bank could start scaling back its government debt purchases. As bond yields whipsawed in response in June 2013, banks got a glimpse of the risks of rate swings in June 2013 and saw their long term assets briefly lose billions of dollars in value.
 
Many lenders remain comfortable offering long-term loans to bolster earnings as roughly a quarter of the loans on bank balance sheets will not mature for at least five years, shows FDIC data.
 
"We are relatively convinced that we may not be this low forever, but...our expectation is lower for longer," Wells Fargo's finance chief, John Shrewsberry, said last month.
 
Approaches vary across the industry as regulators let banks use their own models to calculate risks and do not require them to set aside capital for potential losses if interest rates rise.
 
While Bank of America Corp, the nation's No. 2 lender, has been steadily paring it back, JPMorgan Chase & Co, the nation's largest lender, has lately increased its protection against rising rates.
 
(Source:www.reuters.com) 






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