What does a declining interest rate environment typically encourage banks to do with their asset allocation?

In a declining interest rate environment, banks often find it advantageous to focus on more rate-insensitive assets. When interest rates decrease, the income generated from variable-rate loans or short-term investments tends to decrease as well. As a result, banks may seek to stabilize their returns by investing in assets that are less sensitive to fluctuations in interest rates.

Rate-insensitive assets, such as fixed-rate securities or long-term bonds, may provide a more consistent yield, enhancing the bank's overall return in a low-rate environment. This strategy can help banks manage their interest rate risk effectively while still generating revenue, enabling them to achieve more predictable income streams.

Furthermore, investing in rate-insensitive assets allows banks to lock in higher yields from existing assets before rates potentially fall further. In contrast, shifting towards short-term loans or rate-sensitive assets could expose banks to increased risk as those returns would likely decline with falling rates. Thus, focusing on more rate-insensitive assets is a prudent strategy during periods of declining interest rates.