The U.S. Federal Reserve (Fed) has taken significant steps to support banks in the face of risks associated with rising interest rates. However, regulators must act to make the banking system safer in the long term.

During the pandemic, banks received a massive influx of deposits and invested in long-term bonds and government-guaranteed mortgage-backed securities. This made banks vulnerable to fluctuations in the value of these assets in the event of rising interest rates.

To prevent a run on banks, the Fed implemented an emergency program that involves lending to banks in exchange for their bonds as collateral, up to the face value of those bonds. This program protects banks from unrealized losses on their bonds and reassures depositors.

However, this temporary support measure may encourage banks to take excessive interest rate risks. Regulators must, therefore, strengthen the safety of the banking system. One solution is to remove certain exemptions enjoyed by mid-sized banks and subject them to the same accounting and liquidity rules as large banks, as is the case in Europe.

Regulators must also establish a regime that takes into account risks associated with rising interest rates. They could subject banks to stress tests to assess their ability to cope with variations in the value of their assets if interest rates increase.

In summary, regulators must act to ensure the safety of banks and depositors in the face of interest rate fluctuations, while avoiding creating a climate of fear and fragility for consumers and taxpayers.