A team of economists says rising interest rates have hollowed out many U.S. banks' assets.
If large depositors notice that, and they withdraw about half of the deposits not covered by Federal Deposit Insurance Corp. deposit insurance, that could make more than 5% of the banks insolvent, according to a new working paper posted by the National Bureau of Economic Research.
A working paper is a research paper that has not yet gone through a full academic peer review process.
Erica Xuewei Jiang, an economist at the University of Southern California business school, and three colleagues estimate that 186 of the 2,315 banks in their data set could become insolvent if depositors responded to asset value shortfalls by taking out half of the banks' uninsured deposits.
What It Means
If Jiang's team is correct, the state of banks' asset holdings could be of interest even to insurance agents and financial advisors who have no direct professional involvement with banks and bank deposits.
The Backdrop
U.S. interest rates have increased rapidly in the past year, because the Federal Reserve Board sees increasing rates as a good way to get people to borrow less money, spend less and cool inflation.
When interest rates rise, the resale prices of fixed-rate bonds, mortgages and mortgage-backed securities fall enough so that the current yields on those secondhand assets equal the yields on new, similar fixed-rate assets with comparable credit ratings.
If a bank or life insurer actually sells those fixed-rate assets now and loses money, it must "mark the values to market" and "realize the losses." That means the losses are included in net income.
In many cases, if a financial services company keeps the fixed-rate assets with resale values hurt by rising interest rates, it may be able to keep the reduction in asset market value out of its net income and other closely watched financial performance indicators.
