In recent years many banks have attempted to improve the measurement and management of credit risk by assigning risk ratings to business loans. Virtually all large banks now assign such ratings. However, until recently there has been little information on the use of risk ratings by smaller banks. Recent revisions to the Federal Reserve's Survey of Terms of Business Lending and telephone consultations with more than 100 banks on the survey panel provide data on the prevalence and precision of risk rating systems at banks of all sizes. We find that the use of risk rating systems is quite widespread, but that smaller banks generally have less detailed systems than do larger banks. In addition, the new survey data allow us to asses the relationships between loan risk ratings and loan terms. Not surprisingly, riskier loans generally carry higher interest rates, even after taking account of other loan terms. There are more complex relationships between loan risk and other loan terms. Regression results indicate that banks of all sizes price for risk. We do not find a relationship between reported loan risk and delinquency and charge-off rates. However, this may reflect how recently the risk rating data have become available.

Because they engage in maturity transformation, a steepening of the yield curve should, all else equal, boost bank profitability. We re-examine this conventional wisdom by estimating the reaction of bank intraday stock returns to exogenous fluctuations in interest rates induced by monetary policy announcements. We construct a new measure of the mismatch between the repricing time or maturity of bank assets and liabilities and analyze how the reaction of stock returns varies with the size of this mismatch and other bank characteristics, including the usage of interest rate derivatives. Our results indicate that bank stock prices decline substantially following an unanticipated increase in the level of interest rates or a steepening of the yield curve. A large maturity gap, however, significantly attenuates the negative reaction of returns to a slope surprise, a result consistent with the role of banks as maturity transformers. Share prices of banks that rely heavily on core deposits decline more in response to policy-induced interest rate surprises, a reaction that primarily reflects ensuing deposit disintermediation. Results using income and balance sheet data highlight the importance of adjustments in quantities--as well as interest margins--for understanding the reaction of bank equity values to interest rate surprises.

Financial market observers have noted that during periods of high market volatility, correlations between asset prices can differ substantially from those seen in quieter markets. For example, correlations among yield spreads were substantially higher during the fall of 1998 than in earlier or later periods. Such differences in correlations have been attributed either to structural breaks in the underlying distribution of returns or to "contagion" across markets that occurs only during periods of market turbulence. However, we argue that the differences may reflect nothing more than time-varying sampling volatility. As noted by Boyer, Gibson and Loretan (1999), increases in the volatility of returns are generally accompanied by an increase in sampling correlations even when the true correlations are constant. We show that this result is not just of theoretical interest: When we consider quarterly measures of volatility and correlation for three pairs of asset returns, we find that the theoretical relationship can explain much of the movement in correlations over time. We then examine the implications of this link between measures of volatility and correlation for risk management, bank supervision, and monetary policy making.