When market interest rates rise, existing fixed-rate bonds become less attractive compared with newly issued bonds that pay higher coupons — so the market price of older bonds falls. For banks that hold lots of long-term, fixed-rate securities while funding themselves with short-term deposits, those falling bond prices can turn into large unrealised losses that become real in a liquidity squeeze. That mechanism was a key factor in the 2023 failures of Silicon Valley Bank, Signature Bank and First Republic.
The mechanics: why bond prices fall when market interest rates rise
A bond is simply a promise: the issuer pays fixed coupons (interest) and returns principal at maturity. Suppose you buy a plain vanilla bond with:
- face (par) value = $1,000
- coupon = 5% → annual coupon payment = $50
- maturity = 5 years
If market interest rates (the yield investors require) are 5%, new bonds pay 5% and your bond trading at par ($1,000) is competitive. But if market rates rise to 6%, new bonds offer 6% → $60 per year on a $1,000 face. Your bond still pays only $50 a year, so buyers will only pay less than $1,000 to get an effective yield of 6%.
Price is just the present value of the bond’s future cash flows discounted at the market rate. Numerically:
- Present value of coupons = $50 × (1 − (1+0.06)^−5) / 0.06 ≈ $210.62
- Present value of maturity (principal) = $1,000 × (1+0.06)^−5 ≈ $747.26
- Bond price ≈ $210.62 + $747.26 = $957.88
So when the required yield rises from 5% to 6%, the bond’s market price falls from $1,000 to about $957.88 — a drop of $42.12 (≈4.2%). The bigger the remaining life of the bond (the longer the maturity) and the lower its coupon relative to the new market rate, the larger the price drop. (This is the basic inverse relationship between rates and prices.)
To know how to calculate bond’s market price, visit here.
Intuition and risk: coupons, maturity and duration
Coupon size: Lower-coupon bonds lose more value when interest rates rise because a larger portion of their total return comes from the principal payment at maturity rather than from periodic coupon payments. This happens because earlier cash inflows are more valuable than later ones due to the time value of money.
For example, if one bond pays a $50 semiannual coupon and another pays $100 annually with the same maturity, the semiannual-paying bond will be more valuable and less sensitive to interest rate changes since it delivers cash to investors sooner.
Maturity / Duration: the longer the maturity, the more sensitive the bond’s price to rate changes. Duration (a weighted average time of cash flows) is the standard measure of that sensitivity: approximate percent price change ≈ −Duration × change in yield. Long-dated, low-coupon bonds have high duration and therefore large price sensitivity.
How this becomes a banking problem: accounting, liquidity and runs
Banks traditionally transform maturities: they take short-term deposits and invest in longer-term assets (loans, mortgage securities, long-term Treasuries). That earns a spread in normal times. But when interest rates rise rapidly:
- Market value of the bank’s existing long-term bonds falls (unrealised losses). If those securities are held at amortised cost on the balance sheet, the losses might not show up immediately as accounting losses — they are unrealised. But they still exist economically.
- Depositors can demand cash. If depositors withdraw funds and the bank must raise cash, it may have to sell those long-term securities into a market where their prices are depressed — thereby crystallising the losses. If withdrawals are large and fast enough, the bank becomes illiquid.
- A liquidity problem can become solvency or confidence problem: once depositors or counterparties learn the bank would need to sell securities at a loss, they may rush to withdraw — producing a classic bank run or contagion. Regulators and markets react quickly when several institutions show similar vulnerabilities.
This link — rising rates → bond price falls → unrealised losses → potential forced sales and deposit runs — explains why interest-rate management and hedging matter a lot for banks.
Real world case studies: SVB, Signature Bank and First Republic
Silicon Valley Bank (SVB)
SVB had a concentrated deposit base (technology startups and venture-backed firms) and a large portfolio of long-duration, fixed-rate securities (Treasuries and mortgage-backed securities) accumulated when rates were low. As the Federal Reserve raised rates aggressively in 2022–2023, those securities lost market value. Facing larger cash outflows from its concentrated depositor base, SVB announced a securities sale and a capital raise; that announcement triggered a very rapid withdrawal of deposits and ultimately closure by regulators in March 2023. The bank’s inability to sell securities without large losses — and the resulting liquidity run — was central to the failure.
Signature Bank
Signature’s failure followed closely and was driven by rapid deposit outflows after other regional bank problems, plus exposures related to digital-asset customers. The bank experienced severe illiquidity; contagion dynamics and the speed of deposit flight, not just underlying credit losses, forced its closure. Again, unrealised losses on securities and the composition of funding (how many uninsured, flight-prone deposits) mattered.
First Republic
First Republic relied heavily on large uninsured deposits from wealthy clients and had long-dated assets. In 2023 it survived initial stress only to be hit by subsequent deposit runs and contagion from the other failures. Regulators’ reviews later concluded that unrealised interest-rate losses on fixed-income assets held at amortised cost, concentrated funding risk and the rapid run of uninsured deposits were key contributors to its failure. JPMorgan ultimately acquired much of First Republic’s deposits and assets under FDIC resolution.
A broad supervisory and industry review (including BIS and FDIC reports) concluded that unrealised interest-rate losses on held-to-maturity or amortised-cost securities were an important proximate driver of these failures and of the wider 2023 regional banking stress.
Why managing interest-rate risk matters — for banks and for policy
Liquidity management: Banks must match the liquidity profile of assets and liabilities or hold enough high-quality liquid assets to meet withdrawal risk. Concentrated or uninsured deposit bases raise the probability of quick outflows.
Interest-rate risk hedging: Banks can hedge the interest-rate exposure of long term securities (e.g., using interest-rate swaps, futures, or hedging programs). SVB’s case illustrated what happens when hedging is inadequate or delayed.
Prudent accounting and disclosure: If too much value is hidden as “unrealised”, markets may be surprised when those losses have to be realised under stress. Transparent risk reporting, stress testing and supervisory oversight flag vulnerabilities earlier.
Interest-rate path and macro policy: Rapid, large moves in policy rates create heightened risks across the financial system — not just credit risk but also market-value losses. Central banks and regulators must factor in transition risks when tightening policy, and banks must prepare for that scenario.
Lessons and policy implications
For banks: actively manage duration, diversify funding sources (limit large concentrations of uninsured/flight-prone deposits), and use appropriate hedges for interest-rate risk.
For regulators: strengthen supervision of interest-rate risk and uninsured deposit assumptions; require more forward-looking liquidity stress tests and earlier intervention triggers.
For investors and depositors: understand that deposit safety depends not only on insurance limits but on a bank’s funding mix and risk management — particularly in a fast-moving rate environment.
Conclusion
The inverse relationship between bond prices and market interest rates is elementary in fixed-income markets — but the 2023 U.S. regional bank failures show how that simple math can cascade into systemic stress when combined with concentrated funding, insufficient hedging, and rapid rate moves. Policymakers, bank managers and depositors should not treat duration losses as mere accounting items; in times of stress they can become the spark that turns liquidity problems into bank failures. Understanding and managing interest-rate risk is therefore a core discipline — not optional housekeeping.
Sources:
SEC investor bulletin: When interest rates go up, prices of fixed-rate bonds fall. SEC
Investopedia primers on price/yield mechanics. Investopedia+1
Fed OIG material loss review and related FDIC reports on Silicon Valley Bank, Signature Bank and First Republic. oig.federalreserve.gov+2FDIC+2
BIS/BCBS report on the 2023 banking turmoil and the role of unrealised interest-rate losses. Bank for International Settlements
Reuters coverage of regulatory/legal follow-ups. Reute