In finance, the winds of change are blowing, and banks are bracing themselves for a potential storm. Treasury yields are on the rise, and this surge is causing ripples throughout the financial industry. As bank stocks face the possibility of yearly losses due to sharply higher interest rates, one thing remains clear: banks are prepared.

DBRS Morningstar reports that the banking industry’s reserves are currently at their highest levels in three decades. This impressive financial cushion is handy as bank shares come under increasing selling pressure. The Federal Reserve’s announcement in September that it might maintain higher rates for an extended period has had a profound impact, dampening the year’s stock market rally and reigniting a dramatic selloff in the roughly $25 trillion Treasury market.

Kathy Jones, the chief fixed-income strategist at Schwab Center for Financial Research, notes, “Right now, nothing is standing in the way of higher Treasury yields. It’s fairly obvious it’s not good for banks. The rise in yields has just been relentless.”

The challenge for banks lies in the erosion of portfolios’ value, including lower coupon debt issued when rates were lower. Additionally, banks tend to hold significant exposure to commercial property loans that could become difficult to refinance if rates remain elevated for an extended period.

The numbers reflect this pressure on bank stocks. The S&P 500 financial sector and the popular Financial Select Sector SPDR ETF XLF were down 5.5% in 2023 through Tuesday.

DBRS Morningstar analysts Eric Chan and Michael Driscoll suggest that while credit losses may continue to climb, the banking industry, bolstered by reforms following the 2007-2008 global financial crisis, is positioned to “weather any potential storms.”

Kathy Jones at Schwab adds, “That’s logical. They are saying: Things don’t look so great right now. I’m going to have to be more careful.”

Banks face additional challenges as they grapple with unrealized losses on underwater securities, which increased by 8.4% in the year’s second quarter. The exposure to commercial real estate, especially among regional lenders, has raised concerns about potential fallout from higher rates or a recession.

According to Dow Jones Market Data, regional banks have borne the brunt of this year’s selloff in bank stocks, with The SPDR S&P Regional Banking ETF KRE down approximately 32% in 2023.

The collapse of Silicon Valley Bank in March sent shockwaves through the industry as it sold an extensive portfolio of securities at a sharp loss. In response, the Fed established an emergency lending facility to provide liquidity to banks and prevent forced asset sales. While demand for the facility spiked in September, it also helped restore confidence in the banking industry.

The march higher in longer-dated Treasury yields has significantly impacted U.S. bond-market returns, with the iShares Core U.S. Aggregate Bond ETF AGG closing at its lowest level since October 2008.

Yields on the 10-year Treasury and 30-year Treasury have reached 4.80% and 4.92%, respectively, according to FactSet. Jones at Schwab suggests that the 10-year Treasury yield could climb even higher this year, potentially reaching 5% or even 5.5% in a “vastly oversold” scenario.

As the financial landscape shifts, the Dow Jones Industrial Average and the S&P 500 index have also felt the effects. The Dow Jones Industrial Average turned negative for the year, while the S&P 500 index trimmed its yearly gain.

Banks are standing firm in this uncertain financial climate, armed with reserves and strategies to weather the storm brought on by surging Treasury yields. The path ahead may be challenging, but one thing is sure: the banking industry is prepared for whatever lies ahead.