Surprised by interest rate hikes? Really?

The recent chaos in the banking system caused by a simple increase in interest rates has left many baffled. Why did this happen with interest rates still not high by historical standards? Banks should have risk managers to protect them against likely happenings. Yet, here we are, experiencing a crisis of the conspicuously clear, a predicament of the perfectly predictable.

Herd mentality is an explanation for the unexpected behavior of banks. The herd’s behavior can shape reality: if everyone thinks a bank is insolvent, that bank will fail. Moreover, the pack can run in the wrong direction for a long, and the market can stay irrational longer than you can stay solvent.

Banks should have known better than to take risks without proper risk management. For example, they should have known that increasing interest rates was possible, especially after zero interest rates during the pandemic. Moreover, regulators failed when they did not consider the possibility of rising interest rates, as evidenced by the Silicon Valley Bank’s recent failure.

The solution lies in proper risk management, regulators considering all possibilities, and avoiding the herd mentality. For example, accountants and economists have been discussing bank interest rate risk for ages, and banks must take it more seriously. Moreover, regulators need to be more vigilant in their stress testing.

Related Facts:

– The Federal Reserve recently raised interest rates despite the risk of further convulsions.
– Banks and the economy did just fine in the late 1990s when the Fed funds rate was significantly higher.
– Herd mentality is not entirely irrational and can shape reality.

Key Takeaway:

The banking system’s recent chaos caused by a simple increase in interest rates was due to herd mentality and the failure of banks and regulators to manage risk appropriately. To prevent such crises, banks need proper risk management, regulators need to consider all possibilities in their stress testing, and the herd mentality needs to be avoided.

Conclusion:

The recent chaos in the banking system caused by a simple increase in interest rates was not surprising, as banks and regulators failed to manage risks and ignored the possibility of rising interest rates. Therefore, avoiding herd mentality and prioritizing proper risk management is crucial to prevent such crises.