Derivatives have become an essential instrument for hedging risks, yet moral hazard can lead to their misuse by problem banks. Given that the absence of comprehensive data on bank derivatives activities prevents an accurate assessment of bank risk-taking, banks have an opportunity to take unmonitored second bets. Thus, troubled banks have the motive to increase risk, and derivatives provide the means to do so. The role of bank supervisors should be to limit the opportunity through more comprehensive data reporting requirements and closer supervisory scrutiny of derivatives activity at problem banks. Because a relatively large number of banks active in the derivatives market have low capital ratios and are considered institutions with a significant risk of failure by bank supervisors, the possible misuse of derivatives by troubled banks should be of concern to regulators. However, we find no evidence that the volume of derivatives activity at troubled banks affects the probability of formal regulatory intervention or even a downgrade in supervisory rating.
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Length: 41 pages Date of creation: Nov 1996 Date of revision: Handle: RePEc:boc:bocoec:358
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Find related papers by JEL classification: G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Gary Gorton & Richard Rosen, 1995.
"Banks and Derivatives,"
NBER Chapters,
in: NBER Macroeconomics Annual 1995, Volume 10, pages 299-349
National Bureau of Economic Research, Inc.
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