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How Much Do Banks Use Credit Derivatives to Reduce Risk?

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  • Minton, Bernadette A.

    (Ohio State U)

  • Stulz, Rene M.

    (Ohio State U)

  • Williamson, Rohan

    (Georgetown U)

Abstract

This paper examines the use of credit derivatives by US bank holding companies from 1999 to 2003 with assets in excess of one billion dollars. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2003 only 19 large banks out of 345 use credit derivatives. Though few banks use credit derivatives, the assets of these banks represent on average two thirds of the assets of bank holding companies with assets in excess of $1 billion. Few banks are net buyers of credit protection and disclose using credit derivatives to hedge loans. Banks are more likely to be net protection buyers if they engage in asset securitization, originate foreign loans, and have lower capital ratios. The likelihood of a bank being a net protection buyer is positively related to the percentage of commercial and industrial loans in a bank’s loan portfolio and negatively or not related to other types of bank loans. The use of credit derivatives by banks is limited because adverse selection and moral hazard problems make the market for credit derivatives illiquid for the typical credit exposures of banks.

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Bibliographic Info

Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2005-17.

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Date of creation: Jul 2005
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Handle: RePEc:ecl:ohidic:2005-17

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  1. Douglas W. Diamond & Raghuram G. Rajan, 1999. "A Theory of Bank Capital," NBER Working Papers 7431, National Bureau of Economic Research, Inc.
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Cited by:
  1. Christian Upper, 2007. "Using counterfactual simulations to assess the danger of contagion in interbank markets," BIS Working Papers 234, Bank for International Settlements.
  2. Gabriella Chiesa, 2008. "Optimal Credit Risk Transfer, Monitored Finance, and Banks," EIEF Working Papers Series 0811, Einaudi Institute for Economics and Finance (EIEF), revised Sep 2008.
  3. Bannier, Christina E. & Hänsel, Dennis N., 2007. "Determinants of banks' engagement in loan securitization," Frankfurt School - Working Paper Series 85, Frankfurt School of Finance and Management.
  4. Nijskens, Rob & Wagner, Wolf, 2011. "Credit risk transfer activities and systemic risk: How banks became less risky individually but posed greater risks to the financial system at the same time," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1391-1398, June.
  5. Nicolò, Antonio & Pelizzon, Loriana, 2008. "Credit derivatives, capital requirements and opaque OTC markets," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 444-463, October.
  6. Fecht, Falko & Wagner, Wolf, 2009. "The marketability of bank assets, managerial rents and banking stability," Journal of Financial Stability, Elsevier, vol. 5(3), pages 272-282, September.
  7. James R. Thompson, 2007. "Credit Risk Transfer: To Sell or to Insure," Working Papers 1131, Queen's University, Department of Economics.
  8. Franklin Allen & Douglas Gale, 2007. "Systemic Risk and Regulation," NBER Chapters, in: The Risks of Financial Institutions, pages 341-376 National Bureau of Economic Research, Inc.
  9. Thorsten V. Koeppl & James MacGee, 2007. "Branching Out: The Urgent Need to Transform Canada’s Financial Landscape and How to Do It," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 251, June.
  10. James R. Thompson, 2007. "Counterparty Risk in Insurance Contracts: Should the Insured Worry about the Insurer?," Working Papers 1136, Queen's University, Department of Economics.
  11. Til Schuermann & Kevin J. Stiroh, 2006. "Visible and hidden risk factors for banks," Staff Reports 252, Federal Reserve Bank of New York.
  12. Hirtle, Beverly, 2009. "Credit derivatives and bank credit supply," Journal of Financial Intermediation, Elsevier, vol. 18(2), pages 125-150, April.
  13. Hänsel, Dennis N. & Bannier, Christina E., 2008. "Determinants of European banks' engagement in loan securitization," Discussion Paper Series 2: Banking and Financial Studies 2008,10, Deutsche Bundesbank, Research Centre.
  14. Goderis, Benedikt & Marsh, Ian & Vall Castello , Judit & Wagner, Wolf, 2007. "Bank behaviour with access to credit risk transfer markets," Research Discussion Papers 4/2007, Bank of Finland.
  15. Marsh , Ian W, 2006. "The effect of lenders’ credit risk transfer activities on borrowing firms’ equity returns," Research Discussion Papers 31/2006, Bank of Finland.
  16. zhang, zhichao & Xie, Li & lu, xiangyun & zhang, zhuang, 2014. "Determinants of financial distress in u.s. large bank holding companies," MPRA Paper 53545, University Library of Munich, Germany.
  17. Larry E. Jones & Rodolfo E. Manuelli, 2001. "Endogenous Policy Choice: The Case of Pollution and Growth," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(2), pages 369-405, July.

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