Interest Rate Derivatives and Asset-Liability Management by Commercial Banks

by Katerina Simons
January/February 1995

Bank participation in derivative markets has risen sharply in recent years. The total amount of interest rate, currency, commodity, and equity contracts at U.S. commercial and savings banks soared from $6.8 trillion in 1990 to $11.9 trillion in 1993, an increase of 75 percent. A major concern facing policymakers and bank regulators today is the possibility that the rising use of derivatives has increased the riskiness of individual banks and of the banking system as a whole.

This study uses quarterly Call Report data to shed some light on the pattern of derivative use by U.S. commercial banks. It finds that among banks with assets of less than $5 billion, larger banks tend to use interest rate swaps more intensively, while no clear relationship was found between size of bank and other interest rate derivatives. In addition, the study found that for banks with more than $5 billion in assets, those with weaker asset quality tend to be more intensive users of derivatives than banks with better asset quality. However, the author points out that these results, while intriguing, do not give a clear indication of how derivatives are used to manage interest rate risk, or whether they are used to increase or reduce that risk.

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