US Regional Banks Under Pressure: The Stress Test the Fed Didn't Intend

By Alessandro Mazzarini / 16 Jan 2026

The years following the Federal Reserve’s sharp rate hikes have been marked by evident financial instability, not only in markets, with uncertainty and high volatility, but especially at a structural level. The US regional banking system has borne the brunt of the monetary policy shift and, alongside it, non-financial entities reliant on interest-rate-sensitive business models have shown clear signs of vulnerability.

Emblematic were the case of Silicon Valley Bank’s (SVB) failure and the plunge in market indices of major regional banks in March 2023. The aggregate ETF for US regional banks (KRE) recorded a -7% drop in a single session during that crisis period. The causes, particularly for SVB, stemmed from a duration mismatch: long-dated Treasury securities held in portfolio suffered markdowns due to rising yields, eroding liquidity buffers and funding capacity. The concentrated deposit base proved unstable, leading to a bank run once unrealized losses became binding.

In 2025, signs of renewed stress have reemerged in the regional credit system, this time transmitted through credit channels rather than valuation effects. Impairments have stemmed from rising borrower default rates, exacerbated by lax underwriting standards, fraud and falsified collateral valuations. Prominent cases include the collapse of Tricolor Holdings—a subprime auto-finance platform later linked to fraud allegations—and First Brands, a highly leveraged firm in the automotive sector. These seemingly isolated events have rippled through the local banking system: Zions Bancorporation and Western Alliance Bancorp have set aside hundreds of millions of dollars to cover default risks on impaired loans and have pursued legal action over fraud involving disputed collateral 

It is legitimate to question the nexus between these disparate dynamics.

The unifying factor is the stress induced by the abrupt and persistent rise in real interest rates, which since 2022 remain elevated despite recent Fed Funds cuts, still exceeding inflation. The Fed’s monetary tightening has effectively operated as an implicit stress test on the banking system, probing balance sheets optimized for a regime of persistently low real rates, with extended duration exposures, high leverage and migrations toward riskier or more opaque credits, sustained by low-cost refinancing.

The framework developed by Akinci, Benigno, Del Negro and Queralto in “The Financial (In)Stability Real Interest Rate” formalizes this idea through the concept of r**, the financial stability real interest rate. This is neither a policy target nor a natural rate, but a latent threshold: the real rate level at which banks’ financing constraints become binding. Below r**, intermediaries operate in a tranquil regime, with adequate net worth, compressed spreads and shock-absorption capacity. Above r**, net worth no longer supports existing balance sheets, triggering a stress regime with margin pressures, asset sales and capital erosion.

Crucially, r** is not an external parameter imposed from outside the system: it is endogenously shaped by the behavior of financial intermediaries themselves. During prolonged periods of low real interest rates, rising leverage, longer duration exposures and systematic reach-for-yield mechanically lower this financial stability threshold. By optimizing balance sheets around easy funding conditions, banks reduce their potential elasticity to a future contraction in liquidity, allowing fragility to accumulate precisely when macro conditions appear stable. 

The chart below illustrates the decline in r** during the sustained low-rate period ('20-'23), showing how vulnerabilities paradoxically build up in phases that appear benign for balance sheets and public perception.