Do Banks Hedge Using Interest Rate Swaps?

We analyze whether banks use interest rate swaps to hedge the interest rate risk of their assets, primarily loans and securities. By examining regulatory data on individual swap positions from the largest 250 U.S. banks, we find that banks hold large swap positions with an average notional value of $434 billion. However, after accounting for offsetting swap positions, the average bank exhibits almost no net interest rate risk from swaps: a 100-basis-point increase in rates reduces the value of its swaps by only 0.1% of bank equity. The variation in swap positions across banks indicates that banks use swaps to hedge interest rate risk, thereby facilitating risk transfer within the banking sector. Additionally, we find that swap dealer banks primarily hold swap positions for market making, while non-dealer banks use swaps to meet borrower demand for fixed-rate loans. Despite the substantial notional amounts, our findings suggest that swap positions are not economically significant in hedging the overall interest rate risk of bank assets. Instead, banks primarily rely on their deposit franchise to hedge interest rate risk.