The sharp rise in interest rates since 2022 has brought renewed attention to banks’ exposure to valuation losses on long-term securities. The collapse of Silicon Valley Bank made it clear how quickly these losses can materialise and trigger instability when risks are left unhedged. A growing body of evidence suggests that this lack of hedging was not an isolated anomaly but rather a widespread feature of the US banking system (McPhail et al. 2023, Jiang et al. 2023, Fuster et al. 2024). Whether banks outside the US similarly leave their securities portfolios exposed, or instead actively manage interest rate risk through derivatives, remains an open question.

In recent work (Bianchi et al. 2026), we provide new evidence from Italy on this issue. Using granular supervisory data on Italian banks between 2021 and 2024, we show that banks do hedge interest rate risk, and, crucially, that they increase hedging when rates rise. The evidence is based on transaction-level data on interest rate swaps combined with detailed securities holdings, allowing us to directly measure how exposures evolve at a weekly frequency.

Derivatives provide significant, but partial, insurance against losses on bond portfolios induced by interest rate increases. We measure the interest rate risk (IRR) exposure of a financial contract as the change in its present value resulting from a hypothetical 100 basis point parallel upward shift of the yield curve. Figure 1 shows that, on average over the full period, such an increase in rates leads, for the Italian banking system, to losses of around 0.9% of risk-weighted assets (RWA) on bonds held at amortised cost (AC) and about 0.5% on bonds accounted for at fair value (FV). At the same time, swap positions generate gains of roughly 0.5% of risk-weighted assets. This implies that derivatives offset around one third of the losses on the overall bond portfolio, a ratio that is in line with estimates for the entire euro area banking system in Hoffmann et al. (2019) and more recent ones for the 2022-25 tightening in Guerrini and Rice (2025).

Figure 1 Impact of a 100-basis-point increase in rates on swaps and bonds

Dynamic hedging during the monetary policy tightening

Our main contribution focuses on the pattern of securities hedging over time. Figure 2 shows the evolution of the combined interest rate risk exposure of bonds and swaps alongside the ECB deposit facility rate. As the tightening cycle begins in mid-2022, the net exposure of the banking system becomes progressively less negative. This occurs despite the continued accumulation of bond holdings, implying that banks actively increase derivative-based protection as interest rate risk materialises. This is consistent with a dynamic view of risk management: rather than adjusting only asset quantities, banks adjust the hedging intensity of their portfolios in response to macroeconomic conditions.

Figure 2 Combined interest rate risk exposure of swaps and bonds

Econometric estimates confirm this pattern. Following the start of ECB tightening, hedging intensity – measured by the negative co-movement between securities’ and swaps’ interest rate risk exposures at weekly frequency – increased by around 6%, while positive monetary policy surprises and increases in forward rates are associated with even stronger hedging responses. This points to a state-dependent model of risk management: banks do not passively absorb monetary policy shocks but actively adjust their hedging intensity through derivatives as macroeconomic conditions evolve. 

We find that not all banks hedge to the same extent. During the tightening cycle, institutions with lower capital ratios hedge more aggressively, which suggests that capital buffers and derivatives may be substitutes in protecting against financial distress, as predicted by Ahnert et al. (2025). Funding structure matters as well. Banks with a larger share of wholesale funding increase hedging more strongly, while banks with a larger deposit base hedge less. This is exactly what the deposit franchise view in Drechsler et al. (2021) would predict: deposits themselves may act as a built-in hedge, reducing the need for derivatives.

The evidence we find on Italian banks’ dynamic hedging patterns contrasts with that for the US.

Why might Italian and US banks behave differently?

A first possible reason, highlighted in Acharya et al. (2024), is supervisory treatment of interest rate risk. In the euro area, the European Banking Authority’s Interest Rate Risk in the Banking Book (IRRBB) framework explicitly focuses on the economic value of the banking book, requiring banks to measure how rate shocks affect the present value of loans, deposits, and securities – including amortised cost securities. This means that even when accounting rules shield bond portfolios from mark-to-market losses, those losses remain relevant for supervisory assessments, strengthening incentives to hedge. In the US, by contrast, held-to-maturity accounting and capital rules allow many banks to keep unrealised losses on securities largely outside regulatory capital. This weakens the immediate prudential cost of duration risk and reduces the incentive to hedge unless liquidity stress forces asset sales. 

A second difference may relate to the state-dependent role of the deposit franchise as highlighted by Lu and Lingxuan (2026). When depositors are inattentive and deposit rates adjust slowly, deposits provide a strong hedge against rising rates; when competition intensifies and deposit betas increase, this protection weakens. This suggests that the relative importance of deposits and derivatives as hedging tools may differ substantially across banking systems.

Policy implications

The findings in our paper have important implications. 

First, a focus on securities alone may overstate the vulnerability of banks to rising rates. Interest rate risk reflects not only the interaction of assets and liabilities, but also that of hedging instruments. Ignoring derivatives – which has often been the case due to data limitations – would miss a key channel through which banks absorb shocks. 

Second, hedging of interest rate risk through derivatives is endogenous and state-dependent. Hedging intensity increases precisely when interest rate risk becomes salient, and especially so for banks with lower capital ratios. From a macroprudential perspective, this implies that derivative markets should be seen not only as a source of risk, but also as part of the system’s shock-absorbing capacity. Going forward, financial stability authorities should better integrate derivative exposures into top-down stress testing frameworks.

Third, hedging may weaken the bank channel of monetary policy. By offsetting valuation losses on bonds, derivatives reduce the impact of rate increases on bank capital and, therefore, could also mitigate the contraction in credit supply. Assessing the quantitative importance of this channel would constitute an interesting topic for future research. 

References 

Acharya, V, E Carletti, F Restoy and X Vives (2024), Banking Turmoil and Regulatory Reform, The Future of Banking 6, CEPR Press.

Ahnert, T, C Bertsch, A Leonello and R Marquez (2025), “Bank Fragility and Risk Management”, CEPR Discussion Paper No. 19523.

Bianchi, M L, A Segura and D Ruzzi (2026), “Banks’ Dynamic Interest Rate Risk Hedging”, CEPR Discussion Paper No. 21588.

Drechsler, I, A Savov and P Schnabl (2021), “Banking on Deposits: Maturity Transformation without Interest Rate Risk”, Journal of Finance 76: 1091–1143.

Fuster, A, T Paligorova and J I Vickery (2024), “Underwater: Strategic trading and risk management in bank securities portfolios”, CEPR Discussion Paper No. 21036.

Guerrini, G and J Rice (2025), “Interest rate and deposit run risk: New evidence from euro area banks in the 2022-2023 tightening cycle”, VoxEU.org, 22 August.

Hoffmann, P, S Langfield, F Pierobon and G Vuillemey (2019), “Who bears interest rate risk?”, The Review of Financial Studies 32(8): 2921-2954.

Jiang, E X, G Matvos, T Piskorski and A Seru (2023), “Limited hedging and gambling for resurrection by US Banks during the 2022 monetary tightening?”, Available at SSRN 4410201.

Lu, X and L Wu (2026), “Banking on inattention: When deposits hedge or amplify interest rate risk”, VoxEU.org, 16 February. 

McPhail, L, P Schnabl and B Tuckman (2023), “Do banks hedge using interest rate swaps?”, NBER Working Paper 31166.