Banks' Book Value Risk Management: Limited Hedging and HTM Accounting Amid Rising Rates
Study reveals banks' reliance on HTM accounting over derivatives hedging during 2022 rate hikes.
1Limited hedging exposure
Only 6% of U.S. banking assets were hedged with derivatives during 2022's rising rate environment, according to call report and SEC data. Even banks with the most extensive hedging programs protected just a small fraction of their portfolios. This minimal hedging activity occurred despite significant interest rate risk exposure across the banking sector, particularly in long-duration assets.
2HTM accounting surge
Banks reclassified approximately $700 billion of securities as held-to-maturity (HTM) during the tightening period, more than doubling pre-existing HTM amounts. This accounting maneuver allowed institutions to shield book capital from market value fluctuations without actually reducing interest rate risk exposure. The strategy effectively decoupled accounting valuations from economic reality during the rate hike cycle.
3Vulnerability factors
Banks with lower capitalization, fragile uninsured funding structures, and greater long-duration asset exposure showed distinct behavioral patterns. These institutions were both less likely to expand hedging activities and more likely to increase HTM accounting usage during tightening periods. State-regulated banks facing less stringent oversight particularly favored HTM reclassification strategies.
4Regulatory capital implications
The study's model demonstrates how interest rate risk affects bank solvency, run risk, and regulatory capital requirements. HTM accounting creates divergent incentives - helping well-capitalized banks avoid artificial capital constraints while enabling weaker banks to window-dress capital ratios. This accounting treatment may undermine the effectiveness of capital regulation by masking true risk exposures.
5Run risk concerns
HTM accounting's ability to improve reported capital ratios without actually reducing risk creates potential systemic vulnerabilities. Banks using this approach remain exposed to run risk while appearing healthier on paper. The study found this effect particularly pronounced among moderately capitalized banks during the 2022 tightening episode.
6Deposit franchise value gap
Current regulatory capital frameworks fail to adequately account for deposit franchise value in relation to run risk. This oversight may further weaken capital regulation's effectiveness, as banks can exploit the mismatch between accounting treatment and economic reality. The findings suggest needed reforms in how regulators assess bank stability during rate hike cycles.
7Behavioral patterns
Analysis reveals systematic differences in risk management approaches based on bank characteristics and regulatory environments. Less capitalized banks disproportionately relied on HTM accounting rather than hedging or recapitalization. State-regulated institutions showed greater propensity for HTM shifts compared to federally supervised banks.
8Policy implications
The findings challenge current approaches to bank risk management and capital regulation. Accounting treatments that allow capital ratio manipulation without addressing underlying risks may require revision. Regulators may need enhanced tools to monitor and constrain HTM accounting usage, particularly during monetary tightening cycles.