Banks' Risk Exposures

This paper represents U.S. banks’ fixed-income positions, including derivatives, as portfolios with two weights that describe time-varying exposures to interest-rate and credit risk. Our approach exploits the factor structure in fixed-income returns; it allows simple stress tests and concisely summarizes risk-taking over the last 30 years. Before the 2022 crisis, smaller, less-regulated banks increased both exposures. They lost when both risk factors came in low and did not hedge each other, in contrast to earlier times of stress. Moreover, banks systematically increase interest-rate risk exposure ahead of low excess returns on long bonds, consistent with a liquidity-centric business model.