The 2023 US bank failures were caused by a palsy where assets stuck at old interest rates could no longer support new deposit costs.
April 25, 2026
Original Paper
Rate Cycles and Banking Palsy
SSRN · 6584878
The Takeaway
Banking systems suffer from a structural vulnerability during rapid interest rate cycles. Assets that were priced when rates were low become a heavy burden when the central bank hikes rates. This mismatch forces deposits to concentrate in a few massive institutions, weakening the overall stability of the financial system. The failure of individual banks like Silicon Valley Bank was a symptom of this broader systemic flaw. Future monetary policy will be less effective because the banking sector is now more fragile and less competitive. Stability requires a fundamental rethink of how banks manage the gap between long-term loans and short-term deposits.
From the abstract
The three largest U.S. bank failures in history occurred in 2023, and their loan books were clean. They failed because assets priced at yesterday's rates could not support liabilities priced at today's. This paper develops a dynamic model of banking competition with maturity mismatch, monopsonistic deposit markets, and endogenous entry and exit. Five propositions characterize how monetary policy cycles reshape market structure. A rate hike compresses margins on banks holding loans originated whe