Hidden Risks Threaten Balance Sheets as Rate Volatility Returns

Banks face a new era of balance sheet management as interest rate volatility, shifting deposit behavior, and regulatory scrutiny challenge long-established assumptions.

Practitioners warn that institutions must rethink structural hedging, governance, and scenario planning if they are to remain resilient in an increasingly uncertain rate environment.

The greatest risk facing balance sheet managers today may not be interest rates themselves, but the assumptions underpinning how institutions respond to them.

That was the central warning from the Group Head of Asset Liability Management at a leading UK digital bank, who told delegates at CeFPro’s 2026 Risk Evolve conference that many firms have updated disclosures and reporting frameworks while leaving the behavioral models and governance structures beneath them largely unchanged.

In an environment defined by persistent volatility and structural uncertainty, she suggested that this disconnect could leave institutions exposed at precisely the wrong moment.

The senior executive examined how balance sheet management has changed following one of the most turbulent interest rate cycles in decades, challenging many of the assumptions that had previously shaped asset liability management strategies across the banking sector.

She argued that many institutions continue to view current conditions as a post-tightening normalization phase.

In reality, she suggested, markets have entered a period of repricing and uncertainty where traditional assumptions around rate trajectories may no longer be reliable.

The rapid widening of yield curves and significant movement in longer-dated rates despite relatively stable overnight rates demonstrate that structural forces rather than simple directional trends are now driving markets.

“The framing that I want to challenge immediately is the one that treats this as a post-hiking cycle environment,” she said. “That is not normalization. That is a repricing and uncertainty.”

Much of the discussion focused on the role of structural hedging, which has become a major source of earnings stability for many institutions.

The executive argued that structural hedges should no longer be viewed as purely treasury instruments. Instead, they represent strategic capital allocation decisions that require active board and executive oversight.

“The institutions that will sustain this advantage into 27-28 are the ones that treat the hedge not as a treasury execution function, but a strategic capital deployment governed at the CFO and the board level,” she explained.

She highlighted how some institutions accepted negative carry during periods of yield curve inversion in order to preserve long-term hedge effectiveness.

Those decisions, she argued, are now producing significant earnings benefits, demonstrating that structural hedging decisions often have implications far beyond short-term profitability.

The session also explored one of the most important developments to emerge from the 2022-2025 rate cycle: the changing behavior of depositors.

According to the speaker, the industry entered the tightening cycle relying on assumptions that deposit betas would behave relatively predictably. Actual customer behavior proved considerably more complex.