By Matt Scuffham

NEW YORK, (Reuters) – Wall Street banks plan for a prolonged period of high inflation. They run internal health checks to monitor whether clients are able to repay loans.

This month, U.S. consumer price rose to their highest level in 31 years due to increases in gasoline prices and other factors.

Senior bank managers are less persuaded by the central bankers’ claims that the spike in liquidity is temporary, and they have taken a more proactive approach to managing risk.

Banks generally view higher inflation as a plus, increasing net interest income and improving profitability. Top bankers warn that inflation can become a problem if it rises too fast.

Goldman Sachs’ (NYSE:) Chief Operating officer John Waldron identified last month inflation as the number one risk. There are two main risks that could cause the collapse of the global economy as well as stock markets.

Jamie Dimon, Chief Executive Officer of JPMorgan (NYSE) told analysts last month that banks should be concerned about high inflation and high rates of interest increasing the likelihood for extreme price moves.

One senior banker from a European bank that has large U.S. operations stated that a sustained rise in inflation could pose credit and market risks to banks.

Another banker stated that risk teams also monitor credit exposures in the most susceptible sectors to inflation. These include companies in the manufacturing, industrial and consumer discretionary sectors.

According to the banker who requested anonymity because client discussions are confidential, “We’re very active with them, offering hedging protections.”

According to the banker, clients who may require additional funding in order to make it through periods of high inflation should raise capital at low interest rates.

Although it’s still very helpful to have funding available, this won’t continue forever.

The investment bankers assess whether increased inflation and tightening of the monetary environment could affect record transactions and disrupt public offering pipelines.

“We expect a sustained period of higher inflation, and monetary tightening could slow the momentum in the M&A market,” said Paul Colone, U.S.-based managing partner at Alantra, a global mid-market investment bank.

Alantra is advising clients in the early stages of M&A discussions “to review the risks sustained inflation could bring to both valuation and business results,” Colone said.

Clients are calling sales and trading more often to reposition their portfolios. Portfolios are susceptible to losing value. U.S. stock indexes suffered severe damage when inflation exploded in 1970s.

Chris McReynolds stated that clients are showing more interest in inflation protection. Barclays Head of U.S. Inflation Trading.

The Treasury Inflation Protected Securities are popular because they are issued by the U.S. government and are guaranteed to be backed. These securities offer protection from inflation and are very similar to Treasury bonds.

Also, traders are seeing a demand for derivatives offering inflation protection. These include zero-coupon inflation swaps. In these cases, a fixed-rate payment for an investment is exchanged with a rate at inflation.

McReynolds explained that “people are beginning to realize they have an inflation exposure” and advised them to hedge assets and liabilities.

Analysts believe that banks with diverse businesses will do well in times of sustained inflation.

The expectation is that the yield curve will steepen, which will increase overall profits. Trading businesses will benefit from greater volatility and stronger deals. Initial public offerings pipelines will ensure investment banking activity will continue to be healthy.

Dick Bove however, an independent banking analyst and prominent figure, has a very different perspective. The yield curve is expected to flatten due to higher inflation expectations. Profit margins will be impacted.

He said that bank stock prices could rise for 12-18 months. If inflation is not stopped, then bank stock price will plummet.