Bank capital will decline following an increase in interest rates if the value of its

Question

Quizplus · Accepted Answer

When interest rates increase, the market value of fixed-rate assets decreases because new issues in the market offer higher yields, making the existing lower-yielding assets less attractive. If a bank holds more in fixed-rate assets than in fixed-rate liabilities, the decrease in the value of these assets (without a corresponding decrease in liabilities) will lead to a decline in the bank's capital. Fixed-rate liabilities do not decrease in value in the same way because their cost to the bank remains fixed, not directly affecting the bank's capital in the same manner as the assets do.

Bank Capital Will Decline Following an Increase in Interest Rates