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Impact of higher federal funds rates on bank risk during higher inflation in the U.S

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  • Koch, Jascha-Alexander
  • Islam, Mohammad Saiful

Abstract

Since March 2022, U.S. banks are facing rising federal funds rates. After eliminating banks’ reserve requirement in March 2020, higher funds rates became U.S. Federal Reserve System's key instrument to control inflation. However, it is unclear how banks’ risk is affected by rising Fed funds rates in absence of reserve requirements. Therefore, we examine the impact of higher Fed funds rates on banks’ risk indicators. Analyses reveal that higher Fed funds rates favorably impact credit risk – while adversely impacting regulatory capital risk, leverage risk, and insolvency risk. Moreover, the impact of higher Fed funds rates is heterogeneous across banks.

Suggested Citation

  • Koch, Jascha-Alexander & Islam, Mohammad Saiful, 2024. "Impact of higher federal funds rates on bank risk during higher inflation in the U.S," Finance Research Letters, Elsevier, vol. 60(C).
    • Handle: RePEc:eee:finlet:v:60:y:2024:i:c:s1544612323012382
    DOI: 10.1016/j.frl.2023.104866
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    More about this item

    Keywords

    Federal reserve funds rates; inflation; U.S. banks; credit risk; regulatory capital risk; leverage risk; insolvency risk;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting

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