Lessons Learned from a Volatile Rate Cycle
The banking industry has changed dramatically over the past decade. Following years of near-zero interest rates after the Global Financial Crisis, institutions navigated one of the most aggressive monetary tightening cycles in modern history. Since 2022, the Federal Reserve increased short-term interest rates by more than 500 basis points before beginning a gradual easing cycle and more recently a Fed rate hike, creating one of the most challenging operating environments for balance sheet managers in decades.
Higher funding costs, increased deposit competition, changing depositor behavior, heightened liquidity concerns, and evolving regulatory expectations have fundamentally altered the balance sheet management landscape.
Many institutions that positioned for rising rates initially benefited as asset yields repriced faster than funding costs, resulting in stronger margins and earnings growth. However, the operating environment has evolved. Funding costs remain elevated, deposit competition has intensified, liquidity management has become a strategic priority, and uncertainty surrounding the future path of interest rates continues to challenge balance sheet decision-making.
As institutions look ahead, the balance sheet strategies that proved effective during the tightening and subsequent easing cycle may not be optimal in the next phase of the interest-rate cycle. Management teams must now evaluate how their balance sheets perform across a range of potential outcomes, including a higher-for-longer rate environment, a gradual easing cycle, or renewed economic volatility.
Success increasingly depends on understanding the interaction between earnings, liquidity, capital, and risk under multiple scenarios. Institutions that take a strategic, forward-looking approach to balance sheet management will be better positioned to preserve profitability, manage risk, and capitalize on opportunities as market conditions evolve.
Perhaps the most important lesson from the past several years is that balance sheet strategies should not be built around a single interest-rate forecast. Institutions that evaluate multiple outcomes and maintain flexibility are generally better positioned to navigate changing market conditions. A critical component of that flexibility is understanding how the balance sheet responds under a variety of interest-rate scenarios.
Interest-Rate Risk: Understanding Your Exposure
The challenge facing institutions today extends beyond simply preparing for higher or lower interest rates. Instead, management teams must navigate an uncertain rate environment while balancing earnings performance, liquidity, capital preservation, and risk management objectives.
Many institutions benefited during the recent tightening cycle as asset yields repriced more quickly than funding costs. However, rising deposit betas, increased competition for deposits, and higher funding costs have made margin expansion more difficult to sustain. As a result, effective interest-rate risk management requires a comprehensive understanding of both risk and opportunity.
Institutions should evaluate not only traditional measures such as Net Interest Income (NII) sensitivity and Economic Value of Equity (EVE), but also the potential opportunity costs associated with strategic decisions—or the decision not to act. Understanding what may be gained or lost under multiple interest-rate scenarios is critical to developing a balance sheet strategy that supports long-term profitability and resilience.
In some cases, institutions may find that appropriately structured term funding can help mitigate exposure to rising rates, declining rates, or yield curve changes. Funding strategies should be evaluated within the context of the institution's overall ALM profile rather than on a transaction-by-transaction basis.
Managing the Balance Sheet Strategically
Effective balance sheet management requires viewing earnings, liquidity, capital, and risk as interconnected objectives rather than isolated decisions. Actions taken to improve one metric may affect another, making a holistic approach increasingly important in today's environment. Institutions that regularly utilize ALM modeling to evaluate strategic alternatives are often better positioned to identify opportunities, manage risk, and respond to changing market conditions.
Looking Beyond the Short Term
A common challenge is focusing too heavily on short-term results. While one- and two-year planning horizons are useful, interest-rate risk often emerges over longer periods.
For example, the following simulation illustrates an institution that is liability-sensitive during the first two years of the forecast horizon but becomes asset-sensitive thereafter. Understanding how risk evolves over time is critical when evaluating funding strategies. In this example, an institution may choose a two-year advance structure to hedge exposure during the period in which it remains liability sensitive. Extending funding beyond that horizon may provide limited benefit if the balance sheet becomes asset sensitive thereafter.
This example highlights the importance of aligning funding structures with an institution's projected risk profile. Advances with varying maturities and structures can provide flexibility to address specific risk exposures identified through the ALM process.
Institutions should evaluate multiple interest-rate scenarios over extended planning horizons, as a longer-term view often provides a more complete understanding of risk and can uncover opportunities to enhance earnings stability, strengthen balance sheet performance, and improve risk-adjusted returns.
Core Deposits Remain a Strategic Advantage
Core deposits continue to represent one of the most valuable components of a bank’s balance sheet. Despite increased competition and higher deposit betas, relationship-based funding remains a significant source of franchise value.
Institutions should regularly assess whether core deposits are being utilized efficiently and avoid assuming historical deposit behavior will persist indefinitely. The deposit migration experienced during 2022–2024 demonstrated that customers can be more rate-sensitive than many institutions anticipated. Regular review of deposit assumptions, pricing strategies, customer segmentation, and concentration levels remains essential.
As deposit competition evolves, institutions may benefit from diversifying funding sources rather than relying exclusively on deposit growth to support asset expansion.
Liquidity Management Takes Center Stage
The banking events of 2023 reinforced the importance of strong liquidity positions and diversified funding sources. Liquidity can deteriorate much more rapidly than traditional stress assumptions suggest.
Institutions should regularly evaluate:
- Uninsured deposit concentrations
- Funding diversification
- Contingent liquidity sources
- Collateral availability
- Operational readiness to access liquidity facilities
- Deposit runoff assumptions
Maintaining sufficient borrowing capacity and pledged collateral is a critical component of prudent balance sheet management. The lessons of 2023 demonstrated that liquidity planning should extend beyond regulatory requirements. Institutions that regularly assess contingent liquidity sources, maintain operational readiness, and establish diversified funding channels are often better positioned to respond to periods of market stress.
Industry Consolidation Continues
Industry concentration remains one of the most significant long-term trends affecting banking. As illustrated in the following chart, FDIC data show that institutions with more than $250 billion in assets represented less than 5% of industry assets in the mid-1990s. By the first quarter of 2026, that figure had risen to more than 60%.
This trend underscores the importance of disciplined balance sheet management as community and regional institutions continue to compete in an increasingly concentrated banking landscape. As consolidation continues, institutions may increasingly differentiate themselves through customer relationships, specialized expertise, operational efficiency, and disciplined balance sheet management.
Asset Quality and Strategic Funding
Although credit quality has generally remained resilient, institutions should remain vigilant. Higher rates continue to pressure certain borrower segments, while some commercial real estate sectors face ongoing challenges. Diversification across asset classes remains an important risk management tool.
At the same time, funding decisions should support broader balance sheet objectives rather than simply meeting immediate liquidity needs. Appropriately structured funding can help institutions manage interest-rate risk, enhance liquidity, improve earnings stability, support growth initiatives, and strengthen contingency funding plans. Depending on an institution's objectives, funding solutions can be tailored to support loan growth, liquidity management, balance sheet restructuring, or interest-rate risk management initiatives.
In many cases, the greatest challenge facing management teams is not identifying risk, but determining which risks are worth taking in pursuit of long-term earnings and franchise value.
Looking Ahead
While the lessons of the recent rate cycle are still unfolding, one conclusion is clear: institutions that proactively evaluate risk, maintain flexibility, and align funding strategies with long-term objectives will be better positioned to navigate future uncertainty. A disciplined approach to interest-rate risk, liquidity management, funding diversification, and strategic planning can position institutions to remain resilient and competitive regardless of future economic conditions.
The Federal Home Loan Bank of New York remains committed to helping members evaluate funding alternatives, strengthen liquidity positions, and optimize balance sheet performance throughout all phases of the interest-rate cycle. Members are encouraged to contact their Relationship Manager or the Member Services Desk to discuss strategies tailored to their institution's needs.