Yahoo Finance

By Patrick Rucker and Kouichi Shirayanagi

WASHINGTON (Reuters) - Years of stubbornly low interest rates and expectations they will remain low for years to come have prompted U.S. banks to shift their balance sheets in ways that put them at risk if rates suddenly spike, regulators are warning.

Banks have been stocking up on long-term loans, often tied to real estate and property development that promise higher yields than the miniscule returns on short-term debt.

However, the widening gap between long-term loans and mostly short-term funding means higher interest rates could trap banks in a corner: forcing them to pay more to cover their immediate financing needs than they earn on their loans.

The dynamic "raises the interest rate risk issue that we are very focused on," Martin Gruenberg, chairman of the Federal Deposit Insurance Corporation(FDIC), said this week.

Banks are broadly positioned according to the signals the Federal Reserve has been sending — that it will lift rates only gradually and spread the increases over a long period.

Regulators point out, though, that central banks can move quickly too, even if that now appears unlikely. Short-term rates could also climb in a weakening economy, they say.

"(There) could be impacts on the economy apart from monetary policy," Gruenberg said.

The Office of Financial Research, an independent watchdog within the Treasury Department, says banks could be tested by a surprise upheaval like the recent Brexit vote.

"Investors (are) open to heavy losses from large jumps in interest rates, whether from surprises in the Federal Reserve's monetary policy or other shocks," the OFR wrote in a recent report.

The Office of the Comptroller of the Currency also counts interest rate risk among market perils.

This week, Boston Fed president Eric Rosengren warned that banks might already be too exposed to long-term, commercial real estate that could sour and hit the broader economy.

The savings and loan crisis of the 1980s and the early 1990s was the most prominent U.S. example how a spike in short-term rates could wreak havoc in the financial industry.

When the Fed pushed its benchmark rate above 19 percent in the early 1980s, many lenders switched to riskier credits to keep up with a spike in costs. Those loans later soured and contributed to the collapse of hundreds of lenders.

Most recently, banks got a glimpse of the risks of rate swings in June 2013 when then-Fed Chairman Ben Bernanke suggested that the central bank could start scaling back its government debt purchases. As bond yields whipsawed in response, banks saw their long term assets briefly lose billions of dollars in value.