Banks’ Maturity Choices and the Transmission of Interest-Rate Risk

Paolo Varraso

No 616, CEIS Research Paper from Tor Vergata University, CEIS

Abstract: This paper develops a quantitative heterogeneous-bank model to study how interestrate risk transmits through the financial sector. Banks optimally choose their leverage and maturity structure in the presence of limited equity issuance, default risk, and partial deposit insurance. Long-maturity assets carry a premium because they expose banks to valuation losses when interest rates rise. To preserve their franchise value, banks with low net worth relative to risky assets take on less interest-rate risk, despite the presence of risk-shifting incentives associated with deposit insurance. Applying the model to the 2022–2023 monetary tightening, I show that a rapid increase in interest rates can generate large declines in asset prices and equity values even though banks have access to shortterm assets that provide insurance against interest-rate risk. Under the lens of the model a substantial share of the losses in 2022 was predictable, whereas the losses in 2023 were largely unexpected. A shift toward long-term assets during a period of unusually low rates amplified the initial tightening, but a rebalancing toward shorter maturities dampened the transmission of later hikes.

Keywords: Interest-rate risk; heterogeneous banks; aggregate uncertainty; maturity mismatch; leverage (search for similar items in EconPapers)
JEL-codes: E44 G21 (search for similar items in EconPapers)
Pages: 73 pages
Date: 2025-10-11, Revised 2025-10-11
New Economics Papers: this item is included in nep-dge, nep-fdg, nep-mon and nep-rmg
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