Balance Sheets, Interest Rates and Asset-Liability Management

A bank is a machine for holding assets and liabilities that do not match. It borrows short (deposits that can leave the same day), lends long (mortgages, commercial real estate, bonds), and earns the gap between what it is paid and what it pays. That mismatch is the business, not a flaw in it. But it means every bank carries two exposures to interest rates at once: earnings risk (what happens to net interest income when rates move) and value risk (what happens to the market value of assets and liabilities, and therefore to equity). Add a third, liquidity risk (whether depositors leave faster than assets can be turned into cash), and the three together are the subject of asset-liability management (ALM). In 2022–23 the Federal Reserve raised its policy rate from near zero to 5.25–5.50% in sixteen months. US banks' unrealized losses on securities peaked at roughly $684 billion in the third quarter of 2023 (FDIC Quarterly Banking Profile), and three of the four largest bank failures in US history followed within eight weeks: Silicon Valley Bank, Signature Bank and First Republic. This section explains how a bank balance sheet is built, how net interest margin and duration work, why deposit behaviour (the deposit beta and deposit runoff) decides whether a bank is hedged, how securities are accounted for (available-for-sale versus held-to-maturity), how banks hedge with swaps, how ALM is governed, and what 2023 and earlier episodes teach. A worked example runs a stylized $40 billion regional bank through a 300-basis-point rate shock and a deposit run; a checklist sets out the questions to ask of any balance sheet.