The Sensitivity of Bank Net Interest Margins and Profitability to
Credit, Interest-Rate, and Term-Structure Shocks
Across Bank Product Specializations
Gerald Hanweck
Professor of Finance
School of Management
George Mason University
Fairfax, VA 22030
ghanweck@gmu.edu
and
Visiting Scholar
Division of Insurance and Research
FDIC
Lisa Ryu
Senior Financial Economist
Division of Insurance and Research
FDIC
lryu@fdic.gov
January 2005
Working Paper 2005-02
The authors wish to thank participants at the FDIC’s Analyst/Economists Conference, October
7–9, 2003, and at the Research Seminar at the School of Management, George Mason
University, for helpful comments and suggestions. The authors would also like to thank Richard
Austin, Mark Flannery, and FDIC Working Paper Series reviewers for their comments and
suggestions. All errors and omissions remain the responsibility of the authors. The opinions
expressed in this paper are those of the authors and do not necessarily reflect those of the FDIC
or its staff.
Credit, Interest-Rate, and Term-Structure Shocks
Across Bank Product Specializations
Gerald Hanweck
Professor of Finance
School of Management
George Mason University
Fairfax, VA 22030
ghanweck@gmu.edu
and
Visiting Scholar
Division of Insurance and Research
FDIC
Lisa Ryu
Senior Financial Economist
Division of Insurance and Research
FDIC
lryu@fdic.gov
January 2005
Working Paper 2005-02
The authors wish to thank participants at the FDIC’s Analyst/Economists Conference, October
7–9, 2003, and at the Research Seminar at the School of Management, George Mason
University, for helpful comments and suggestions. The authors would also like to thank Richard
Austin, Mark Flannery, and FDIC Working Paper Series reviewers for their comments and
suggestions. All errors and omissions remain the responsibility of the authors. The opinions
expressed in this paper are those of the authors and do not necessarily reflect those of the FDIC
or its staff.
The Sensitivity of Bank Net Interest Margins and Profitability to
Credit, Interest-Rate, and Term-Structure Shocks
Across Bank Product Specializations
Abstract
This paper presents a dynamic model of bank behavior that explains net interest margin
changes for different groups of banks in response to credit, interest-rate, and term-structure
shocks. Using quarterly data from 1986 to 2003, we find that banks with different product-line
specializations and asset sizes respond in predictable yet fundamentally dissimilar ways to these
shocks. Banks in most bank groups are sensitive in varying degrees to credit, interest-rate, and
term-structure shocks. Large and more diversified banks seem to be less sensitive to interest-rate
and term-structure shocks, but more sensitive to credit shocks. We also find that the composition
of assets and liabilities, in terms of their repricing frequencies, helps amplify or moderate the
effects of changes and volatility in short-term interest rates on bank net interest margins,
depending on the direction of the repricing mismatch. We also analyze subsample periods that
represent different legislative, regulatory, and economic environments and find that most banks
continue to be sensitive to credit, interest-rate, and term-structure shocks. However, the
sensitivity to term-structure shocks seems to have lessened over time for certain groups of banks,
although the results are not universal. In addition, our results show that banks in general are not
able to hedge fully against interest-rate volatility. The sensitivity of net interest margins to
interest-rate volatility for different groups of banks varies across subsample periods; this varying
sensitivity could reflect interest-rate regime shifts as well as the degree of hedging activities and
market competition. Finally, by investigating the sensitivity of ROA to interest-rate and credit
shocks, we have some evidence that banks of different specializations were able to price actual
1
Credit, Interest-Rate, and Term-Structure Shocks
Across Bank Product Specializations
Abstract
This paper presents a dynamic model of bank behavior that explains net interest margin
changes for different groups of banks in response to credit, interest-rate, and term-structure
shocks. Using quarterly data from 1986 to 2003, we find that banks with different product-line
specializations and asset sizes respond in predictable yet fundamentally dissimilar ways to these
shocks. Banks in most bank groups are sensitive in varying degrees to credit, interest-rate, and
term-structure shocks. Large and more diversified banks seem to be less sensitive to interest-rate
and term-structure shocks, but more sensitive to credit shocks. We also find that the composition
of assets and liabilities, in terms of their repricing frequencies, helps amplify or moderate the
effects of changes and volatility in short-term interest rates on bank net interest margins,
depending on the direction of the repricing mismatch. We also analyze subsample periods that
represent different legislative, regulatory, and economic environments and find that most banks
continue to be sensitive to credit, interest-rate, and term-structure shocks. However, the
sensitivity to term-structure shocks seems to have lessened over time for certain groups of banks,
although the results are not universal. In addition, our results show that banks in general are not
able to hedge fully against interest-rate volatility. The sensitivity of net interest margins to
interest-rate volatility for different groups of banks varies across subsample periods; this varying
sensitivity could reflect interest-rate regime shifts as well as the degree of hedging activities and
market competition. Finally, by investigating the sensitivity of ROA to interest-rate and credit
shocks, we have some evidence that banks of different specializations were able to price actual
1