We have a kind of “Ask an Austrian Economist” section at LibertyClassroom.com, and someone recently asked:
Peter Schiff has been very outspoken on his show on the idea that a large increase in the interest rates will lead to massive bank failures. He was critical of the stress tests the Fed ran earlier in the year on the banks because they did not assume interest rate hikes, which he felt would collapse the banks and prove that they were not sound. I never understood, however, why interest rate increases in our situation should lead to bank failures. Why would this be so?
Rising interest rates will collapse the capital value (i.e., the market price) of assets banks hold. If they have existing T-bonds at 3% and interest rates on newly issued T-bonds rise to 6%, the price that investors will be willing to pay for the 3% bonds collapses. When that happens, banks become insolvent.