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Increased longer-term bond-buying may harm small, mid-size banks if Fed rates increase

126px-US-FederalReserveSystem-Seal.svgAs part of an effort to boost profits in the low-interest rate environment, some banks have started purchasing more securities, raising concern that their profits will take a hit when the Federal Reserve ups its rates.

Analysts have particularly expressed concern regarding community banks and mid-size regional lenders, which could be hit hardest by higher rates because of their lower fee income and investment earnings, Reuters reports.

Jeremy Stein, a member of the Federal Reserve’s Board of Governors, said recently that low interest rates could have encouraged banks to take more risk that is less apparent.

“The added interest rate exposure itself may be a meaningful source of risk for the banking sector and should be monitored carefully, especially since existing capital regulation does not explicitly address interest rate risk,” Stein said, according to Reuters.

Bankers at smaller institutions have said that they are purchasing the longer-term bonds because they need the added income, and securities purchasing at many regional institutions has also increased. Banks are not seeing the returns on the longer-term bonds, however, because investors have also increased their securities purchasing.

Rate increases typically boost smaller and mid-sized banks’ interest income, as long as asset income rises faster than deposit rates. While banks do report their rising rate sensitivity with U.S. regulators, some bank analysts indicated that procedures used to test their sensitivity may not fully capture the changing marketplace conditions, Reuters reports.

The Federal Reserve is currently considering the risks of keeping rates low and may alter its policy to avoid inflating financial bubbles.