Regulators must get a better handle on interest rate risks at banks "before it’s too late," Sheila Bair, chairman of the Federal Deposit Insurance Corp., said Friday.

Bair said a thorough evaluation must be done at all institutions to protect them against increases in rates, which could threaten the easy earnings that have helped heal the banking system during the credit crunch.

"If there is evidence this risk is building, I think we need to know more about it,” Bair said at an FDIC symposium on interest rate risk management.

Bank regulators earlier this month issued a warning to institutions about interest rate risk. Banks have generated billions of dollars in profits by borrowing at low short-term rates and investing in higher-yielding, long-term assets like Treasuries.

The easy form of funding will diminish when interest rates rise from the historically low levels of the current recession.

Regulators are concerned that banks have not adequately prepared for rate increases, much like how institutions did not prepare for the sharp decline in housing prices that magnified the financial meltdown.

Federal Reserve Vice Chairman Donald Kohn, also speaking at the symposium, said the usual uncertainty about interest rates is compounded by the fact that rates are near zero and the Fed has massively expanded the amount of reserves in the banking system.

"Borrowing short and lending long is an inherently risky business strategy,” Kohn said. "Intermediaries need to be sure that as the economy recovers, they aren’t also hit by the interest rate risk that often accompanies this sort of mismatch in asset and liability maturities.”

The Federal Reserve on Wednesday renewed its pledge to keep interest rates near zero but offered a guardedly upbeat view of the U.S. economy.

Most analysts do not expect the Federal Reserve to raise interest rates until the second half of 2010.

Bair, who has been hailed for her early warnings on subprime lending, said interest rates represent the next big risk for depository banks.

"This problem can become more acute and the vulnerability of banks can rise,” she said.

She noted that regulators failed to be proactive in helping financial institutions manage excessive risk, saying that “most of this crisis could have been avoided.”

Bair said regulators need to learn more about interest rate risk exposure so they do not repeat their mistakes.

"Frankly I don’t know exactly what the future holds,” she said.