When we define a loan beta, we refer to the change in rates charged on new loans or repriced loans relative to market-rate changes, not the change in overall loan yield. You will sometimes see a loan beta analysis that only calculates the overall change in loan yields relative to market rate changes. However, this dilutes and reduces the actual beta by including the yield on loans that cannot be repriced. An institution with a high mix of fixed-rate lending will report lower betas, when in fact the true loan beta can be much higher.

Why loan betas often don’t match rising rates

Looking at some actual experience in the 2016-2019 rising-rate environment reveals that a beta of 1 is probably not the best assumption; the actual rate response to rising rates is often less than 100%. This is due to many factors:

• Many "variable" loans have floors that keep them from lifting off until rates rise enough, although a good model should incorporate that factor.
• Competitive loan pricing pressure can keep rate increases down as commercial loans reset. A market rate like prime or SOFR may have gone up, but you may have decided to reduce spreads to remain competitive.
• Consumer loans can have lower betas in competitive markets when institutions hesitate to raise rates in order to maintain origination volume.
• Sometimes beta values are driven more by a shift in product mix or credit tier. For example, an institution may have reduced the number of loans it made to lower credit grades over a study period, and therefore, the overall average rates declined relative to market rates.
• Not all market indices gain the same – the yield curve shifts.