Theoretical and empirical review reveals substantial unhedged interest rate exposure in US banks, indicating that liquidity interventions alone cannot prevent systemic solvency runs.
Key Points
To review theoretical models and empirical methods assessing how rising interest rates affect bank asset valuations, deposit franchise stability, and solvency run vulnerability.
Synthesized theoretical banking models integrating liquid versus illiquid balance sheet assets, deposit franchise hedging breakdown, and self-fulfilling solvency runs.
Evaluated empirical metrics used to measure the interest rate sensitivity of bank assets alongside valuation models of deposit franchises during calm and crisis conditions.
Theoretical modeling demonstrates that the deposit franchise fails to serve as an effective hedge against asset depreciation during rapid interest rate increases, magnifying balance sheet fragility.
Empirical evidence indicates US banks maintain substantial unhedged interest rate exposure across their asset portfolios, which heavily compounds solvency run risks given high institutional leverage.
Regulatory liquidity support interventions offer only short-term mitigation and remain fundamentally insufficient to resolve structural solvency vulnerabilities caused by asset devaluation.