BUSI 420 Week 5 Group Discussion Board Forum Example

Duration, Deposits and Stewardship: What the 2023 Bank Failures Teach About Interest Rate Risk

Introduction

In March 2023, Silicon Valley Bank failed after depositors withdrew billions of dollars in a single day. Much of the bank's money was invested in U.S. Treasury and agency securities, assets with essentially no risk of default. The puzzle is how a bank could lose so much on safe bonds. The answer lies in interest rate risk, the topic of this module, and in how that risk interacts with the behavior of the people who supply a bank's funds. This essay explains why bond prices fall when rates rise, how duration measures that exposure, what research shows about protecting investors and banks from it, and what a biblical view of stewardship adds.

Why Long Bonds Lose More

To price a bond, every remaining coupon and the face value are each brought back to today at the current market yield, and the results are summed. When yields rise, every future payment is worth less today, and payments far in the future lose the most. Consider three bonds paying a 3 percent annual coupon on $1,000 face value, all priced at par when market yields are 3 percent. If yields rise to 5 percent, their prices fall as follows.

The same two-point increase in yields cost the holder of the 30-year bond about eight times as much as the holder of the 2-year bond. Neither issuer was any less likely to pay; only the discount rate changed.

Duration and Immunization

Duration summarizes this sensitivity. Macaulay duration measures, in years, when on average the investor gets paid back, counting each coupon and the principal in proportion to how much of today's price it represents. For the 10-year bond above, it is about 8.8 years, and modified duration, which divides by one plus the yield, is about 8.5. That means a one-point rise in yields lowers the price by roughly 8.5 percent. The approximation overstates the loss for large changes because the price curve is convex, which is why the actual drop for a two-point rise was 15.4 percent rather than 17 percent.

Duration also points to a defense. Fisher and Weil (1971) tested strategies for investors who need a certain amount of money at a future date. They showed that a portfolio whose duration matches the investment horizon is largely protected, or immunized, against rate changes: if rates rise, prices fall but coupons are reinvested at higher rates, and the two effects roughly offset by the horizon date. Interest rate risk is not the risk of holding bonds; it is the risk of holding bonds whose duration does not match when the money will be needed.

What Happened to the Banks

Banks are natural holders of interest rate risk because they fund long-term assets with deposits that can be withdrawn at any time. Drechsler et al. (2021) showed that, in normal times, the deposit franchise acts as a hedge. Banks pay deposit rates that rise much less than market rates, so when rates climb, the value of cheap, stable deposits rises and offsets losses on long-term assets. The hedge works, however, only if depositors stay.

In 2022, the Federal Reserve raised its policy rate rapidly, and long-term yields rose with it. Jiang et al. (2024) estimated that the market value of U.S. banks' assets had fallen by roughly $2 trillion below their reported book value by early 2023, and that banks with large shares of uninsured deposits faced the greatest danger of runs. Silicon Valley Bank was an extreme case: it had invested heavily in long-duration securities, and most of its deposits came from technology firms and investors whose balances far exceeded the insurance limit. When the bank announced a loss on securities sales, those depositors had every reason to leave first, and the deposit franchise that should have offset the losses disappeared in a day.

The lesson from the research is that duration must be matched not only to contractual maturities but to how the funding will behave under stress. The same logic applies to an individual saver. A retiree who holds a long bond fund to pay living expenses over the next two years has the same mismatch Silicon Valley Bank had, on a smaller scale: if rates jump just before the money is needed, the fund must be sold at a loss. A ladder of bonds maturing in each of the next several years, by contrast, delivers cash when it is needed whatever happens to rates. A bank whose depositors are few, large and closely connected has a much shorter effective funding horizon than one with many small, insured accounts.

A Biblical View of Stewardship and Risk

Scripture treats money as a trust to be managed faithfully. Jesus told of servants entrusted with talents: the two who invested and doubled their master's money heard "well done," while the third, who buried the sum because he was afraid, was condemned (English Standard Version Bible, 2001/2016, Matthew 25:14-30). Faithful stewardship therefore accepts some risk; holding bonds to earn a return is not wrong. Yet Scripture also counsels prudence about risks that cannot be foreseen. The Teacher counsels spreading one's portion among seven, even eight, since nobody can foresee which calamity will strike (English Standard Version Bible, 2001/2016, Ecclesiastes 11:2), a principle that applies to maturities as well as to borrowers.

Together these passages describe a middle path. A steward should neither bury capital nor stake it on a single assumption, such as interest rates staying low. For an individual investor, that means choosing bond durations that fit when the money will be needed and spreading holdings across maturities. For a bank, it means knowing who its depositors are and how quickly they could leave. Jesus also observed that whoever is faithful in a very little is faithful in much (English Standard Version Bible, 2001/2016, Luke 16:10), a reminder that careful attention to an unglamorous measure like duration is part of faithfulness with what has been entrusted.

Conclusion

The 2023 bank failures did not involve risky borrowers; they involved safe bonds held for too long a horizon by an institution whose depositors could leave overnight. Bond pricing explains the losses, duration measures them, and immunization research shows how to manage them. A biblical view of stewardship supports the same conclusion: accept the risk needed to make money productive, but diversify and match commitments to the time when the money will be needed.

References

Drechsler, I., Savov, A., & Schnabl, P. (2021). Banking on deposits: Maturity transformation without interest rate risk. The Journal of Finance, 76(3), 1091-1143. https://doi.org/10.1111/jofi.13013

English Standard Version Bible. (2016). Crossway. (Original work published 2001)

Fisher, L., & Weil, R. L. (1971). Coping with the risk of interest-rate fluctuations: Returns to bondholders from naive and optimal strategies. The Journal of Business, 44(4), 408-431. https://doi.org/10.1086/295402

Jiang, E. X., Matvos, G., Piskorski, T., & Seru, A. (2024). Monetary tightening and U.S. bank fragility in 2023: Mark-to-market losses and uninsured depositor runs? Journal of Financial Economics, 159, Article 103899. https://doi.org/10.1016/j.jfineco.2024.103899