Banks that suffered larger losses on securities portfolios during the 2022–23 interest rate increases cut business lending more sharply than other lenders, according to new research published this month by the Federal Reserve Bank of San Francisco. The study, authored by Daniel Greenwald, John Krainer, and Pascal Paul, reveals that the way regulators treat bank securities doesn't just affect financial stability—it also changes how powerfully monetary policy hits the broader economy. When all banks must count unrealized losses in their capital calculations, interest rate moves pack a much stronger punch.
The researchers examined supervisory data from large U.S. banks, focusing on securities portfolios that made up roughly 23% of total bank assets in the fourth quarter of 2021. Agency mortgage-backed securities and Treasury securities accounted for approximately 85% of the total portfolio value. Around 60% of all bank securities were classified as available-for-sale, meaning they're valued at current market prices on balance sheets, while the rest were held-to-maturity and recorded at book value regardless of price swings. About 19% of available-for-sale assets were hedged against potential risk. Banks required to include unrealized gains and losses in regulatory capital—called AOCI-capital banks—showed lending responses several times stronger than banks exempt from that requirement, and researchers couldn't rule out zero response from non-AOCI capital banks.
The study finds that banks experiencing bigger value drops on their available-for-sale portfolios extended relatively less credit to firms, with results driven by unhedged securities. In contrast, the researchers obtained substantially smaller and statistically insignificant results for value changes of held-to-maturity securities and hedged available-for-sale securities that don't affect regulatory capital at any bank. "The regulatory treatment of bank securities therefore not only has financial stability implications but also affects the strength of monetary transmission," the authors write, noting that bank regulation and monetary policy are inherently linked even though they're often considered separately.
The mechanism works through balance sheets: when interest rates climb and security values drop, banks required to mark those losses against regulatory capital see their capital positions deteriorate. To avoid falling short of capital requirements, these banks either raise more equity or cut lending to shrink their risk-weighted assets and strengthen capital positions. The researchers built a structural model calibrated to their empirical findings and ran policy scenarios comparing different regulatory frameworks. Following shocks that match the observed 2022–23 tightening cycle, bank-dependent firms reduced investment by around 2.5 percentage points more after a year in the baseline economy compared with a hypothetical economy where no securities are marked to market. When all securities are marked to market, investment drops roughly 9 percentage points lower at the same point relative to the no-mark-to-market policy, even after accounting for banks holding fewer securities under that regime.
The findings carry clear implications for policy design. If regulators required all banks to reflect every security gain and loss in their regulatory capital—a change discussed after the March 2023 regional bank crisis—monetary policy would become more potent, with stronger effects on credit supply and important consequences for overall investment. The March 2023 stress that hit several regional banks stemmed partly from large portfolios of long-term securities whose market value plunged as rates rose rapidly in 2022, creating unrealized losses widely believed to have sparked depositor withdrawals. Under regulations at the time, unrealized securities losses at such midsize banks didn't pass through to regulatory capital, making them appear relatively well capitalized despite their risk exposure. The research shows that changing this regulatory treatment wouldn't just reduce the risk of future bank collapses—it would fundamentally alter how forcefully interest rate changes flow through to business investment and the real economy.