Time-variation in bank income and expense betas

To determine whether banks are able to hedge interest rate risk by matching interest income and expense betas each year, or only on average over longer time periods.

We use state-space methods to estimate time-varying income and expense betas at the yearly frequency.

We find evidence that banks do match interest income to expense betas at the annual frequency, and the largest banks do the best job of matching interest income to expense sensitivities over time. Conversely, the smallest banks have the largest lag in matching interest income betas to changes in expense betas and have the largest net interest margins (NIM) sensitivity to the short-term rates.

Previous research was limited to constant deposit betas.