Gruenberg: Rising interest rates could cut into bank profitability

The current interest rate environment has had “dramatic effects” on the profitability and risk profiles for banks’ funding and investment strategies, FDIC Chairman Martin Gruenberg said today. Speaking at an international bankers conference, Gruenberg said that because of the higher interest rates, longer-term maturity assets acquired by banks when interest rates were lower are now worth less than their face values, resulting in unrealized losses on securities for most institutions. “The good news about this issue is that banks are generally in a strong financial condition and have not been forced to realize losses by selling depreciated securities,” he added.

Gruenberg noted that last year banks received a typical near-term boost to income as the interest rates they pay on deposits tend to lag increases in the market interest rates they receive on loans. “Over time however, as market interest rates increase, banks will likely need to pay more interest to retain their deposits, or accept some deposit outflows,” he said. “So far, through year-end 2022, we have seen modest decreases in total deposits and modest increases in insured deposits. In aggregate, meaningful deposit outflows have not yet materialized, but banks will need to watch these trends carefully as the interest rate environment evolves.”

Regarding credit risk, Gruenberg said supervisors were paying attention to said one area of supervisory attention was in commercial real estate, where a combination of lower operating income for office buildings—because of high vacancy rates—and a higher cost refinancing is expected to reduce valuations for those properties over time. “Some of the loans financing these properties are whole loans held on the balance sheets of banks, some are syndicated and sold, and many serve as collateral for (commercial mortgage-backed securities),” he said. “There are early indications that delinquencies on office property in CMBS are starting to tick up. The good news is that these default rates remain low at this time.”