Banks' Risk Exposures

This paper measures interest rate and credit risk exposures in U.S. banks’ fixed-income positions over the last 30 years. We exploit the factor structure in fixed-income returns to represent banks’ positions, including derivatives, as simple portfolios. The typical bank is long both risk factors, with interest-rate exposure from derivatives reinforcing that from other business. Until recently, interest-rate exposure hedged credit exposure in times of stress. The 2022-3 crisis was special because both risk factors performed poorly at the same time, hurting especially less-regulated small banks that had built up both exposures. Banks also systematically increase interest-rate risk exposure ahead of low excess returns on long bonds, which we show to be consistent with a liquidity-centric business model.