Advanced Search
MyIDEAS: Login

How Much Do Banks Use Credit Derivatives to Hedge Loans?

Contents:

Author Info

  • Minton, Bernadette

    (Ohio State U)

  • Stulz, Rene
  • Williamson, Rohan

    (Georgetown U)

Abstract

This paper examines the use of credit derivatives by US bank holding companies with assets in excess of one billion dollars from 1999 to 2005. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2005 the gross notional amount of credit derivatives held by banks exceeds the amount of loans on their books. Only 23 large banks out of 395 use credit derivatives and most of their derivatives positions are held for dealer activities rather than for hedging of loans. The net notional amount of credit derivatives used for hedging of loans in 2005 represents less than 2% of the total notional amount of credit derivatives held by banks and less than 2% of their loans. Banks hedge less risky loans more than riskier ones. The banks are more likely to be net protection buyers if they have lower capital ratios, a lower net interest rate margin, engage in asset securitization, originate foreign loans, have more commercial and industrial loans in their portfolio, and have fewer agricultural loans. We conclude that the use of credit derivatives by banks to hedge loans is limited because of adverse selection and moral hazard problems and because of the inability of banks to use hedge accounting when hedging with credit derivatives. Our evidence raises important questions about the validity of the often-held view that the use of credit derivatives makes banks sounder.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.cob.ohio-state.edu/fin/dice/papers/2008/2008-1.pdf
Download Restriction: no

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 2008-1.

as in new window
Length:
Date of creation: Jan 2008
Date of revision:
Handle: RePEc:ecl:ohidic:2008-1

Contact details of provider:
Phone: (614) 292-8449
Email:
Web page: http://www.cob.ohio-state.edu/fin/dice/list.htm
More information through EDIRC

Related research

Keywords:

Other versions of this item:

This paper has been announced in the following NEP Reports:

References

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.:
as in new window
  1. Acharya, Viral V & Johnson, Tim, 2005. "Insider Trading in Credit Derivatives," CEPR Discussion Papers 5180, C.E.P.R. Discussion Papers.
  2. Douglas W. Diamond & Raghuram G. Rajan, 1999. "A Theory of Bank Capital," NBER Working Papers 7431, National Bureau of Economic Research, Inc.
  3. Gorton, Gary B. & Pennacchi, George G., 1995. "Banks and loan sales Marketing nonmarketable assets," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 389-411, June.
  4. Franke, Günter & Krahnen, Jan Pieter, 2005. "Default risk sharing between banks and markets: The contribution of collateralized debt obligations," CFS Working Paper Series 2005/06, Center for Financial Studies (CFS).
  5. Gary Gorton & Nicholas S. Souleles, 2005. "Special purpose vehicles and securitization," Working Papers 05-21, Federal Reserve Bank of Philadelphia.
  6. Karl V. Lins & Henri Servaes & Ane Tamayo, 2011. "Does Fair Value Reporting Affect Risk Management? International Survey Evidence," Financial Management, Financial Management Association International, vol. 40(3), pages 525-551, 09.
  7. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
  8. John R. Graham & Daniel A. Rogers, 2002. "Do Firms Hedge in Response to Tax Incentives?," Journal of Finance, American Finance Association, vol. 57(2), pages 815-839, 04.
  9. Duffee, Gregory R. & Zhou, Chunseng, 1999. "Credit Derivatives in Banking: Useful Tools for Managing Risk?," Research Program in Finance, Working Paper Series qt7g67n911, Research Program in Finance, Institute for Business and Economic Research, UC Berkeley.
  10. Sandeep Dahiya & Manju Puri & Anthony Saunders, 2003. "Bank Borrowers and Loan Sales: New Evidence on the Uniqueness of Bank Loans," The Journal of Business, University of Chicago Press, vol. 76(4), pages 563-582, October.
  11. Alan D. Morrison, 2005. "Credit Derivatives, Disintermediation, and Investment Decisions," The Journal of Business, University of Chicago Press, vol. 78(2), pages 621-648, March.
  12. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  13. Mian, Shehzad L., 1996. "Evidence on Corporate Hedging Policy," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(03), pages 419-439, September.
  14. Geczy, Christopher & Minton, Bernadette A & Schrand, Catherine, 1997. " Why Firms Use Currency Derivatives," Journal of Finance, American Finance Association, vol. 52(4), pages 1323-54, September.
  15. Catherine Schrand & Haluk Unal, 1998. "Hedging and Coordinated Risk Management: Evidence from Thrift Conversions," Journal of Finance, American Finance Association, vol. 53(3), pages 979-1013, 06.
  16. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
  17. Cebenoyan, A. Sinan & Strahan, Philip E., 2004. "Risk management, capital structure and lending at banks," Journal of Banking & Finance, Elsevier, vol. 28(1), pages 19-43, January.
  18. James, Christopher, 1988. "The use of loan sales and standby letters of credit by commercial banks," Journal of Monetary Economics, Elsevier, vol. 22(3), pages 395-422.
  19. 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.
  20. Nance, Deana R & Smith, Clifford W, Jr & Smithson, Charles W, 1993. " On the Determinants of Corporate Hedging," Journal of Finance, American Finance Association, vol. 48(1), pages 267-84, March.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Stulz, Rene M., 2009. "Credit Default Swaps and the Credit Crisis," Working Paper Series 2009-16, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  2. Belkhir, Mohamed, 2013. "Do subordinated debt holders discipline bank risk-taking? Evidence from risk management decisions," Journal of Financial Stability, Elsevier, vol. 9(4), pages 705-719.
  3. Bülbül, Dilek & Lambert, Claudia, 2012. "Credit portfolio modelling and its effect on capital requirements," Discussion Papers 11/2012, Deutsche Bundesbank, Research Centre.
  4. Marti G. Subrahmanyam & Dragon Yongjun Tang & Sarah Qian Wang, 2012. "Does the Tail Wag the Dog? The Effect of Credit Default Swaps on Credit Risk," Working Papers 292012, Hong Kong Institute for Monetary Research.
  5. María Rodríguez-Moreno & Sergio Mayordomo & Juan Ignacio Peña, 2012. "Derivatives Holdings and Systemic Risk in the U.S. Banking Sector," Faculty Working Papers 21/12, School of Economics and Business Administration, University of Navarra.
  6. Jeong-Bon Kim & Li Li & Mary L. Z. Ma & Frank M. Song, 2013. "CEO Option Compensation, Risk-Taking Incentives, and Systemic Risk in the Banking Industry," Working Papers 182013, Hong Kong Institute for Monetary Research.
  7. Malamud, Semyon & Rui, Huaxia & Whinston, Andrew, 2013. "Optimal incentives and securitization of defaultable assets," Journal of Financial Economics, Elsevier, vol. 107(1), pages 111-135.
  8. Stefan Arping, 2012. "Credit Protection and Lending Relationships," Tinbergen Institute Discussion Papers 12-142/IV/DSF48, Tinbergen Institute.
  9. Stefan Arping, 2012. "Credit Protection and Lending Relationships," Tinbergen Institute Discussion Papers 12-142/IV/DSF48, Tinbergen Institute.
  10. Arping, Stefan, 2014. "Credit protection and lending relationships," Journal of Financial Stability, Elsevier, vol. 10(C), pages 7-19.
  11. Norden, Lars & Silva Buston, Consuelo & Wagner, Wolf, 2014. "Financial innovation and bank behavior: Evidence from credit markets," Journal of Economic Dynamics and Control, Elsevier, vol. 43(C), pages 130-145.
  12. Ken Cyree & Pinghsun Huang & James Lindley, 2012. "The Economic Consequences of Banks’ Derivatives Use in Good Times and Bad Times," Journal of Financial Services Research, Springer, vol. 41(3), pages 121-144, June.
  13. Parlour, Christine A. & Winton, Andrew, 2013. "Laying off credit risk: Loan sales versus credit default swaps," Journal of Financial Economics, Elsevier, vol. 107(1), pages 25-45.
  14. Warren Bailey & Lin Zheng, 2013. "Banks, Bears, and the Financial Crisis," Journal of Financial Services Research, Springer, vol. 44(1), pages 1-51, August.
  15. Cerasi, Vittoria & Rochet, Jean-Charles, 2014. "Rethinking the regulatory treatment of securitization," Journal of Financial Stability, Elsevier, vol. 10(C), pages 20-31.
  16. Lamont Black & Chenghuan Chu & Andrew Cohen & Joseph Nichols, 2012. "Differences Across Originators in CMBS Loan Underwriting," Journal of Financial Services Research, Springer, vol. 42(1), pages 115-134, October.
  17. Shim, Ilhyock & Zhu, Haibin, 2014. "The impact of CDS trading on the bond market: Evidence from Asia," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 460-475.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:ecl:ohidic:2008-1. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.