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US banks have scaled up the proportion of long-term, fixed-rate lending they do in a move that generates higher interest income but puts them at greater risk if there is a sharp rise in rates, a leading industry regulator has said.
Figures released this week by the Federal Deposit Insurance Corporation show that US banks are unable to change the terms on about $6.1tn worth of loans and securities for at least three years.
That is equivalent to about 36 per cent of their total assets — the biggest proportion since records began two decades ago and up almost a fifth over the past decade.
The sharpest rise has been in assets that do not mature or reprice for at least 15 years, such as mortgage-backed securities. These now account for almost 13 per cent of the industry’s overall balance sheet compared with about 6 per cent in 1998.
While the shift should support lenders’ income in the short term because longer-dated assets are typically higher yielding, it puts them at greater risk of being caught out by rising interest rates.
“Banks have been extending asset maturities to increase yields and maintain margins in a low-rate environment,” said Martin Gruenberg, chairman of the FDIC, presenting the regulator’s quarterly banking profile. “This has left many institutions more vulnerable to interest-rate risk.”
His caution is a reminder that rising interest rates are not a one-way bet for bank investors, even though the benchmark KBW Bank Index is up about a third since the Federal Reserve embarked on its monetary tightening almost two years ago.
Rising rates should allow lenders to push up interest charges for borrowers, increase rates for depositors more slowly, and pocket the difference. So far, this has played out: net interest margins across the industry rose from 3.18 per cent a year ago to 3.30 per cent in the third quarter, the FDIC data show.
However, banks will be unable to benefit from higher rates on loans for which they have fixed the terms for several years.
The risk is that a sudden or sharp rise in interest rates forces lenders to pay savers higher rates on their deposits than the rates that borrowers pay them on the loans. That is what led to the savings and loan crisis in the 1980s and early 90s, when hundreds of small lenders collapsed.
The FDIC said that smaller banks were “particularly vulnerable” to interest-rate risk because half of their assets matured or repriced in three years or more.
In its profile the regulator gave a clean bill of health to much of the industry. Banks’ return on assets of 1.12 per cent in the third quarter was the second highest in the past decade. Meanwhile there were only 104 banks on the regulator’s “problem” list of institutions at risk of collapse, the smallest number since the start of 2008.