Banks Rethink Interest Rate Risk for a New Cycle

Banks are entering 2026 facing a markedly different rate backdrop from the past two years. 

The US policy rate is lower, the Treasury curve is steeper, and the Federal Reserve has paused after cutting rates in 2025. 

For Sarah McAvoy, Managing Director and Global Treasurer at BNY Mellon, that shift creates both opportunity and renewed complexity.

“Banks are coming into 2026 with a lower US policy rate environment and a steeper Treasury curve than they experienced over the last couple of years, benefitting deposit costs and reinvestment opportunities but potentially pressuring net interest margins,” she explains. 

With uncertainty lingering around the timing and path of future rate moves, she emphasizes that “interest rate risk sensitivity analysis will be critical for banks to implement, ensuring business strategies can weather a range of outcomes.”

Balancing near-term earnings against longer-term capital and interest rate exposures requires disciplined modeling and scenario design. 

While modeling techniques have advanced significantly, regulatory expectations have not always evolved in parallel. 

McAvoy notes that despite lessons from the market stress of March 2023, guidance in the interest rate risk space has lagged compared to liquidity and capital regulation.

“Consistent guidance around such topics as the use of models, the frequency and design of sensitivity analysis, disclosure requirements, and forward views of the impact of interest rate changes have not kept up with either market practice, technology, or the approaches for other risk sleeves,” she says. 

The result has been disparate supervisory approaches and calls for more prescriptive requirements, potentially including quantitative limits. In her view, clearer and more consistent guidance would enhance transparency and strengthen systemic resilience.

Beyond formal modeling, banks must also contend with a more complex macroeconomic environment. 

Inflation dynamics, government debt levels, political developments, and labor market shifts increasingly interact to influence rate expectations. 

McAvoy observes that leading institutions have broadened their monitoring frameworks beyond traditional market surveillance.

“The most successful have incorporated traditional market surveillance with more sophisticated social media monitoring, internal data mining, and application of AI techniques to track and analyze emerging trends and risks,” she says.