The interest rate cycle that began in 2022 is often described as a stress test for banks. In reality, it is something more revealing: a structural audit of balance sheets that had quietly accumulated risk during a decade of low rates.

As rates rose rapidly, many banks discovered that their greatest exposure was not credit quality or liquidity in isolation, but the way assets and liabilities responded to change at different speeds. Long-dated, fixed-rate assets sat on balance sheets funded by liabilities that repriced almost immediately. When funding costs moved and asset yields did not, net interest margins absorbed the shock.

Interest rate swaps returned to the center of ALCO discussions, not as sophisticated financial instruments, but as practical tools to address this mismatch. Yet their role has often been misunderstood. Swaps are not directional bets on rates. They are mechanisms designed to reshape how a balance sheet behaves across scenarios.

The structure at the heart of the issue remains common. Banks originate long-term fixed-rate loans, particularly in commercial and relationship-based lending, while relying on deposits and wholesale funding that behave like floating-rate liabilities. This model appears stable in benign environments. It becomes fragile when rates move quickly.

A straightforward example illustrates the problem. A bank issues a 10-year fixed-rate commercial loan at 5%. From an income perspective, the loan provides predictability. From an ALM perspective, it introduces duration risk. The funding side of the balance sheet reprices as market rates rise, either contractually or through behavioral changes in deposit pricing.

During the 2022–2023 tightening cycle, deposit betas increased faster than many institutions had modeled, particularly among rate-sensitive customers. The result was margin compression driven not by asset performance, but by structural repricing asymmetry