Variable Deposit Betas and Bank Interest Rate Risk Exposure

50 Pages Posted: 12 Oct 2023 Last revised: 21 Mar 2024

See all articles by Mustafa Emin

Mustafa Emin

Tulane University

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Tao Li

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: August 22, 2023

Abstract

Following the global financial crisis, banks lengthened the maturity of their assets relative to their liabilities, principally through increasing their investments in mortgage-related assets. Whether this type of maturity transformation exposes banks to interest rate risk depends in part on the effectiveness of bank deposits as a hedge against interest rate shocks. In this paper, we provide evidence that, despite an increase in the average maturity of bank assets, the duration of bank equity was negative for most of the post-financial crisis era. We document that an important factor contributing to the decrease in the duration of bank equity was an increase in the average duration of deposits due to a positive relation between deposit betas and the level of interest rates. The dynamic nature of the deposit betas also explains why deposits provided a poor hedge against recent rate hikes and declines in the value of bank long term fixed rate assets. We provide corroborative evidence concerning the impact of variation in deposit betas on bank interest rate risk exposure using a text based analysis of bank earnings conference calls. Overall, we provide evidence that variable deposit betas contribute to the negative convexity of bank equity and variations in bank interest rate risk exposure.

Keywords: Interest Rate Risk, Hedging, Deposit Betas

JEL Classification: G21, G38

Suggested Citation

Emin, Mustafa and James, Christopher M. and Li, Tao, Variable Deposit Betas and Bank Interest Rate Risk Exposure (August 22, 2023). Available at SSRN: https://ssrn.com/abstract=4598126 or http://dx.doi.org/10.2139/ssrn.4598126

Mustafa Emin

Tulane University ( email )

1440 Canal St.
NEW ORLEANS, LA 70112

Christopher M. James (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

Tao Li

University of Florida - Department of Finance, Insurance and Real Estate ( email )

Warrington College of Business
Gainesville, FL 32611
United States

HOME PAGE: http://warrington.ufl.edu/contact/profile.asp?WEBID=7628

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