Bank Franchise as a Stabilizing Force

Kwan, Simon H.; Martinez, Zinnia

Journal Article

Bank Franchise as a Stabilizing Force

Abstract: The banking shock of 2023 stemmed from banks’ exposure to interest rate risk by gathering short-term funds to invest in long-term assets. When interest rates rose rapidly during the monetary tightening cycle, banks incurred significant capital losses on their long-term assets, some of which were unrealized on their financial statements. However, bank franchise value—the present value of all future excess profits—which is also unrecognized, could hedge against the losses and provide some stability. Moreover, the potential loss of franchise value could discourage risk-taking, further stabilizing the banking system.

Keywords: interest rates; interest rate risk; banking; bank franchise value;