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Derivatives Activity at Troubled Banks

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  • Joe Peek

    ()
    (Boston College)

  • Eric S. Rosengren

    (Federal Reserve Bank of Boston)

Abstract

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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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 358.

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Length: 41 pages
Date of creation: Nov 1996
Date of revision:
Handle: RePEc:boc:bocoec:358

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References

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  1. Jagtiani, Julapa & Saunders, Anthony & Udell, Gregory, 1995. "The effect of bank capital requirements on bank off-balance sheet financial innovations," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 647-658, June.
  2. Gary Gorton & Richard Rosen, . "Banks and Derivatives," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 6-95, Wharton School Rodney L. White Center for Financial Research.
    • 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.
  3. Robert B. Avery & Allen N. Berger, 1988. "Loan commitments and bank risk exposure," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 36, Board of Governors of the Federal Reserve System (U.S.).
  4. John H. Boyd & Mark Gertler, 1993. "U.S. Commercial Banking: Trends, Cycles, and Policy," NBER Working Papers 4404, National Bureau of Economic Research, Inc.
  5. Koppenhaver, G. D. & Stover, Roger D., 1991. "Standby letters of credit and large bank capital: An empirical analysis," Journal of Banking & Finance, Elsevier, vol. 15(2), pages 315-327, April.
  6. Sinkey, Joseph F, Jr, 1975. "A Multivariate Statistical Analysis of the Characteristics of Problem Banks," Journal of Finance, American Finance Association, American Finance Association, vol. 30(1), pages 21-36, March.
  7. Gary Whalen & James B. Thomson, 1988. "Using financial data to identify changes in bank condition," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 17-26.
  8. Katerina Simons, 1995. "Interest rate derivatives and asset-liability management by commercial banks," New England Economic Review, Federal Reserve Bank of Boston, issue Jan, pages 17-28.
  9. Joe Peek & Eric S. Rosengren, 1995. "Banks and the availability of small business loans," Working Papers, Federal Reserve Bank of Boston 95-1, Federal Reserve Bank of Boston.
  10. Sinkey, Joseph F, Jr, 1978. "Identifying "Problem" Banks: How Do the Banking Authorities Measure a Bank's Risk Exposure?," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 10(2), pages 184-93, May.
  11. Peek, Joe & Rosengren, Eric, 1995. "Bank regulation and the credit crunch," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 679-692, June.
  12. Joe Peek & Eric S. Rosengren, 1996. "Will Legislated Early Intervention Prevent the Next Banking Crisis?," Boston College Working Papers in Economics, Boston College Department of Economics 359, Boston College Department of Economics.
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Cited by:
  1. Joshua Charap & Jelena Pavlovic, 2009. "Development of the Commercial Banking System in Afghanistan," IMF Working Papers 09/150, International Monetary Fund.
  2. Chiara Oldani, 2005. "An Overview of the Literature about Derivatives," Macroeconomics, EconWPA 0504004, EconWPA.
  3. Brock, W.A. & Hommes, C.H. & Wagener, F.O.O., 2006. "More hedging instruments may destabilize markets," CeNDEF Working Papers 06-12, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  4. L. Baele & R. Vander Vennet & A. Van Landschoot, 2004. "Bank Risk Strategies and Cyclical Variation in Bank Stock Returns," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium, Ghent University, Faculty of Economics and Business Administration 04/217, Ghent University, Faculty of Economics and Business Administration.
  5. R. Vander Vennet & O. De Jonghe & L. Baele, 2004. "Bank risks and the business cycle," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium, Ghent University, Faculty of Economics and Business Administration 04/264, Ghent University, Faculty of Economics and Business Administration.
  6. Helwege, Jean, 2010. "Financial firm bankruptcy and systemic risk," Journal of International Financial Markets, Institutions and Money, Elsevier, Elsevier, vol. 20(1), pages 1-12, February.

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