Book Value Risk Management of Banks: Limited Hedging, HTM Accounting, and Rising Interest Rates

56 Pages Posted: 3 Apr 2024

See all articles by Joao Granja

Joao Granja

University of Chicago - Booth School of Business

Erica Xuewei Jiang

University of Southern California

Gregor Matvos

Northwestern University - Kellogg School of Management

Tomasz Piskorski

Columbia University - Columbia Business School, Finance

Amit Seru

Stanford University

Multiple version iconThere are 2 versions of this paper

Date Written: April 2, 2024

Abstract

In the face of rising interest rates in 2022, banks mitigated interest rate exposure of the accounting value of their assets but left the vast majority of their long-duration assets exposed to interest rate risk. Data from call reports and SEC filings shows that only 6% of U.S. banking assets used derivatives to hedge their interest rate risk, and even heavy users of derivatives left most assets unhedged. The banks most vulnerable to asset declines and solvency runs decreased existing hedges, focusing on short-term gains but risking further losses if rates rose. Instead of hedging the market value risk of bank asset declines, banks used accounting reclassification to diminish the impact of interest rate increases on book capital. Banks reclassified $1 trillion in securities as held-to-maturity (HTM) which insulated these assets book values from interest rate fluctuations. More vulnerable banks were more likely to reclassify. Extending Jiang et al.’s (2023) solvency bank run model, we show that capital regulation could address run risk by encouraging capital raising, but its effectiveness depends on the regulatory capital definitions and can by eroded by the use of HTM accounting. Including deposit franchise value in regulatory capital calculations without considering run risk could weaken capital regulation’s ability to prevent runs. Our findings have implications for regulatory capital accounting and risk management practices in the banking sector.

JEL Classification: G2,G21,G28

Suggested Citation

Granja, Joao and Jiang, Erica Xuewei and Matvos, Gregor and Piskorski, Tomasz and Seru, Amit, Book Value Risk Management of Banks: Limited Hedging, HTM Accounting, and Rising Interest Rates (April 2, 2024). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2024-37, Available at SSRN: https://ssrn.com/abstract=4781916 or http://dx.doi.org/10.2139/ssrn.4781916

Joao Granja (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 South Woodlawn Avenue
Room 326
Chicago, IL 60637
United States

Erica Xuewei Jiang

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Gregor Matvos

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Tomasz Piskorski

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

Amit Seru

Stanford University ( email )

Stanford, CA 94305
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
65
Abstract Views
186
Rank
604,425
PlumX Metrics