Riding the Rate Wave: Interest Rate and Runrisks in Euro Area Banks During The2022-2023 Monetary Cycle

Abstract

This paper examines how the ECB’s 2022–2023 interest-rate hikes affected euro-areabanks’ economic net worth and vulnerability to deposit runs. Drawing on granular,confidential data for 139 banks, we estimate each bank’s economic net worth and findthat unrealised losses on loans and bonds averaged around 30 per cent of equity. BySeptember 2023, however, roughly half of these losses had been offset by gains fromthe deposit franchise and interest-rate swaps. We develop a theoretical frameworklinking banks’ economic net worth and deposit-rate setting to depositor behaviourand run incentives. Further results indicate that banks with larger unrealised lossesraised their deposit rates by less - a pattern we interpret as banks leveraging amore valuable deposit franchise to fund longer-duration assets. Although euro-areabanks as a whole avoided widespread runs, several institutions nonetheless carriedsubstantial mark-to-market losses, suggesting latent fragilities.

Keywords: Interest rate risk, bank runs, monetary policy, asset valuations, euro areabanking system.