More Than 700 Banks Face Significant Safety and Soundness Risk Due To Unrealized Losses, Says Federal Reserve Report

According to a February presentation released by the Federal Reserve, more than 700 banks face significant safety and soundness risk due to massive unrealized losses on their balance sheets.

The banks have self-reported unrealized losses that exceed 50% of their capital and have been taking steps to try and avoid further losses for months, the presentation, titled "Impact of Rising Rates on Certain Banks and Supervisory Approach," revealed.

“Banks with large unrealized losses face significant safety and soundness risks. Securities have traditionally been used for liquidity purposes; Today, the unrealized losses are causing some banks to face tough choices,” the presenters — whose names were redacted — noted. The report was presented by two individuals, one of whom was from the Federal Reserve's Supervision and Regulation Division while the other was from the Federal Reserve Bank of Kansas City.

The presenters also pointed out that the spike in interest rates is exacerbating challenges facing many banks.

“The rising interest rate environment is increasing financial risks for many banks. We are concerned with banks that have investment portfolios with large unrealized loss positions,” they wrote. “As rates rise, investment portfolios which have traditionally been a source of liquidity will be further limited.”

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The presenters added that there are "higher than anticipated deposit outflows and limited available contingency funding," which may cause banks to make difficult choices, including a "reliance on higher-cost wholesale funding or curtailing lending."

Citing the troubled Silicon Valley Bank (SVB), the presenters wrote that the bank used significant deposit growth "to purchase longer maturity securities." They added that SVB’s purchase yields were low due to "the rate environment and portfolio duration increased." 

Throughout the presentation, the authors argued that the banks must proactively assess and manage risks to remain safe and sound. 

Earlier this month, the Fed raised the fed funds rate by 25 basis points to a range of 5%-5.25%, delivering the tenth hike in the tightening cycle and bringing the cost of borrowing to its highest since September 2007.

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