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Originally published November 2023 | Updated July 2026
Unrealized losses still matter because they reveal how vulnerable banks can become when interest rates rise, bond values fall, and depositors demand liquidity. Even if losses remain “on paper,” they can pressure confidence, funding costs, lending appetite, and capital flexibility, especially when banks face deposit competition and tighter credit conditions.
Key Takeaways:
U.S. banks are no longer sitting on the nearly $700 billion in unrealized losses seen around the 2023 stress period, but losses remain elevated. The FDIC reported $325.1 billion in unrealized losses on securities in Q1 2026.
The Fed’s Bank Term Funding Program helped stabilize the system after the 2023 bank failures, but it stopped making new loans on March 11, 2024.
Unrealized losses are not automatically fatal, but they become dangerous when banks need liquidity, lose deposits, or are forced to sell securities.
Bank fragility is not just about interest rates. It is about confidence, funding costs, lending standards, credit demand, and balance sheet flexibility.
The main risks today are still deposit competition, tighter credit conditions, pressure on net interest margins, and stress in areas like commercial real estate and consumer credit.
Banks have looked increasingly fragile over the few years - since the Fed began it's rate tightening cycle.
And besides the three of the four largest U.S. bank failures happening in early 2023, many feel like the worst is over.
But I remain skeptical.
That's because banks are still sitting on enormous unrealized losses and dealing with compressed profit margins.
To put this into perspective – as of U.S. banks are currently sitting on about $306 billion in unrealized losses.
Simply put – it’s a loss that occurs on paper when the current market value of an asset or investment falls below the price originally paid for the asset, but the asset hasn’t yet been sold.
For example, imagine buying stock and it falls 25%. Technically, you don’t realize that loss until you actually sell it.
And because of this unrealized loss problem, the Fed had to open the discount window (aka where banks can swap assets for reserves at full value with the Fed) and other programs like the Bank Term Funding Program (BTFP).
If they hadn’t, banks would’ve had to likely sell these assets at steep losses on the market – potentially causing a wave of further insolvencies (wiping out bank capital).
So, what now?
Well, I believe the banking system is still fragile, and it’s not likely to get better as long as growth fades and short-term rates remain elevated.
The latest Q4-2023 results from Charles Schwab highlighted this. . .
Via Bloomberg2 - Schwab said net new assets fell 48% to $66.3 billion in the fourth quarter while net income also dropped by almost half. Bank deposits in the period declined 21% to $290 billion and the company’s total retail brokerage accounts fell short of analyst estimates at 34.8 million.
Meanwhile, the U.S. is laying plans3 to “force” banks to use the Fed’s discount window at least once a year now to make it cheaper for banks to borrow from them.
Keep in mind that most banks don’t like to use the Fed’s discount window because it implies something may be wrong.
Imagine if everyone knew you needed Mom and Dad to bail you out, it’s not a good look and hurts confidence. And in banking, confidence is everything.
Thus, I believe there are three big factors still negatively affecting banks:
Banks tightening lending standards sharply amid growing economic uncertainty and deteriorating fundamentals. Reinforcing the decline in the money supply (which is deflationary).
The higher short-term rates have caused deposits to leave banks and rotate into money-market funds (MMFs). Putting pressure on bank stability.
Higher short-term rates compared to long-term market rates (aka the inverted yield curve) decrease bank profitability, thus squeezing their net profit margins (NIMs) and causing loan growth to erode.
I believe side-effects from banking issues – such as declining loan creation – are what’s worrying as it historically leads to instability and deflation.
So, let’s take a closer look into all this and why banks may be stuck for a while. . .
Digging Through The Weeds Of Banking And Its Commonly Held Misconceptions
Banking is a wildly complex topic – with many dynamic variables.
Many may downplay the importance of “financial plumbing” – but I believe it is critical in understanding an economy and asset markets.
But I will try to cover what I can and break it down as simply as possible so it’s not dry, but rather compelling.
Before we start, there are a few misconceptions about banking – such as:
1. Deposits (liabilities for a bank) fund loans (an asset for a bank).
2. That the central bank ‘prints’ (creates) money into the economy.
3. That banks lend because of interest rates.
These three things are generally false ideas many have been taught about modern banking.
For instance, the central bank doesn’t print anything. It adds reserves with a few keystrokes (think of reserves as a checking account banks use with each other to clear payments).
For example, if Person A at Chase Bank sends, let’s say $10,000, to Person B at Citibank. Then Chase Bank must send the same number of reserves to Citibank.
Why does this matter?
Well for starters, in theory, if the central bank adds more reserves into the system (through programs such as Quantitative Easing – QE), it should allow banks to lend more.
The problem? Well, they don’t have to lend.
This is known as a ‘liquidity trap’ - aka when banks and consumers hoard money instead of lending and spending, regardless of monetary easing.
This is what happened in Japan post-1991, the Eurozone post-2011, and China currently – all saw central banks pushing on a string.
How Modern Banking Actually Works
But the truth is, the real money creators are commercial banks.
See – contrary to conventional wisdom – in the modern banking system, bank loans create deposits.
A bank doesn’t check how many deposits it has before making a loan. It simply extends credit. And this becomes buying power for the new borrower.
Have you ever heard of anyone going to a bank wanting a loan and hearing the desk employee say, “Ah geez, let me check if we had enough deposits come in today so I can write you a loan.”
To highlight this point, the Bank of England (BoE) wrote an excellent and in-depth whitepaper4 on this topic.
But for those who don’t want to fall asleep reading the BoE’s white paper (I almost did), here’s the gist in a graphic.
Figure 2: Bank of England, 2014 Q1
The point is that a new loan is an asset for the bank (income generating), but it creates an equal liability (the new deposit on which they owe interest or may leave to another bank or money market fund, etc).
Or - as I like to think about it – the loan is created first and then becomes a deposit.
So, as banks loan more, it increases the money supply (creating deposits as shown in the chart above) via more individuals taking out debt to buy something - which then, in turn, gets deposited into the seller’s bank, and on and on.
This is important because it means that banks are the true money and credit allocators – choosing where they shovel it out to – which are most often in asset-backed areas such as the financial sector, housing, and corporations (as they offer more collateral to back the loan). Thus, fueling asset inflation.
Asset-price inflation is the nominal rise in the prices of stocks, bonds, real estate, and other assets. Rising asset prices are potentially misleading signs of a growing economy. Financial assets can be sensitive and volatile and may create an illusion of growth through asset bubbles (remember pre-2008?)
But it’s also important to note the opposite of this - that when debt repayment increases faster than loan creation, the money supply will shrink.
So, what makes banks lend more?
Many were taught that it is interest rates that influence lending. And while it does to an extent, confidence is what drives credit.
Banks extend credit when they feel confident in repayment, liquidity conditions, and financial system health.
For example – during 2008 – banks stopped lending to each other and extending marginal credit even with interest rates at zero because of economic uncertainty. Thus, rendering the Fed’s easing programs relatively mute for stimulating the economy.
To highlight this point, look at interbank lending between U.S. commercial banks between 2007 and 2010 - it completely collapsed and remained anemic until 2017, when the Fed “conveniently” stopped publishing this data.
Figure 3: St. Louis Fed (DISCONTINUED 2017)
I know this may sound counterintuitive and confusing, but this is how modern banking works.
See, for instance, the Fed (or any central bank) can slash interest rates to zero – or even negative. But they can’t control if borrowers will respond to it.
A lower interest rate, in theory, should stimulate borrowing and lending. But doesn’t mean it always happens (as we’ve seen in history).
So, keep these three things in mind for the next part. . .
Three Risks Still Facing Banks
The banking system is not in the same place it was in early 2023. But that does not mean fragility has disappeared.
I see three main risks that still matter.
1. Deposit Competition Is Still a Funding Problem
Higher short-term rates gave depositors more options.
For years, banks benefited from cheap deposits. But when money-market funds, Treasury bills, and high-yield savings accounts started offering better yields, depositors had a reason to move cash.
That forced banks to compete harder for deposits or rely on more expensive funding sources.
This matters because deposits are one of the cheapest and most important funding sources for banks. When deposits leave or become more expensive, bank profitability gets squeezed.
That can lead banks to pull back on lending, tighten standards, or become more defensive with their balance sheets.
2. Lending Standards Remain Tight in Important Areas
Banks create credit when they feel confident about repayment, collateral values, liquidity, and the broader economy.
When confidence fades, lending slows.
The Fed’s April 2026 Senior Loan Officer Opinion Survey showed that banks, on balance, reported tighter lending standards for commercial and industrial loans in the first quarter of 2026. Demand was basically unchanged for C&I loans, while demand for several consumer loan categories weakened.
That is not a crisis signal by itself. But it does show that credit conditions are not roaring back.
And that matters because bank lending is a major source of money creation in the modern economy.
When banks lend, they create deposits. When lending slows and debt repayment runs ahead of new credit creation, money growth can weaken.
That is why tighter credit conditions can become deflationary over time.
3. Net Interest Margins Can Stay Under Pressure
Banks generally benefit when they can borrow short and lend long at a healthy spread.
But when short-term funding costs remain high and longer-term asset yields do not adjust enough, profitability can get squeezed.
This is the net interest margin problem.
If banks have to pay more to retain deposits while holding older, lower-yielding assets, earnings pressure can build. That does not automatically mean failure. But it can reduce the incentive to lend, increase caution, and make banks more sensitive to credit losses.
This is especially important for smaller and regional banks, which often depend more heavily on traditional lending and deposit relationships than the largest diversified banks.
Wrapping It Up
Unrealized losses are lower than their peak, but they are still meaningful. The BTFP helped stabilize the system, but it is no longer making new loans. Deposit competition remains a pressure point. Lending standards are still tight in key areas. And bank profitability can remain squeezed when funding costs stay high.
So, no, unrealized losses do not automatically mean banks are insolvent.
But they do matter.
They matter because banking is built on confidence, liquidity, and balance sheet flexibility. When those weaken, paper losses can become real problems fast.
That is why I remain skeptical of the idea that banking fragility is fully behind us.
The crisis phase may have passed.
The fragility mechanism is still there.
FAQ:
What is an unrealized loss in banking? An unrealized loss occurs when a bank’s asset—such as a bond—has dropped in market value below its purchase price, but hasn’t been sold. These losses only become “realized” when the asset is sold, potentially at a steep discount.
Why don’t banks want to use the Fed’s discount window? Borrowing from the discount window can signal to markets and depositors that a bank is under stress, which can trigger a loss of confidence—critical for financial stability.
How do higher interest rates contribute to banking fragility? Elevated short-term rates encourage depositors to move money to higher-yield money-market funds, draining bank liquidity. At the same time, the inverted yield curve squeezes banks’ net interest margins, making lending less profitable.
Does lowering interest rates guarantee stronger lending? Not necessarily. History shows that bank lending depends heavily on confidence and credit conditions. Even with low rates, banks may restrict lending during uncertain economic periods.
Why is deposit flight a major risk? Deposits are a cheap funding source for banks. When they leave—often for higher-yield alternatives—banks must rely on more expensive funding or cut back lending, both of which can weaken the banking system.
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