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2018 | OriginalPaper | Buchkapitel

2. The Use of Financial Derivatives and Risks of U.S. Bank Holding Companies

verfasst von : Shaofang Li

Erschienen in: Financial Institutions in the Global Financial Crisis

Verlag: Springer Singapore

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Abstract

This chapter examines the impact of financial derivatives on systematic risk of publicly listed U.S. bank holding companies (BHCs) from 1997 to 2012. We find that the use of financial derivatives is positively and significantly related to BHCs’ systematic risk exposures. Higher use of interest rate derivatives, exchange rate derivatives, and credit derivatives corresponds to the greater systematic interest rate risk, exchange rate risk, and credit risk. The positive relationship between derivatives and risks persists for derivatives for trading as well as for derivatives for hedging. We also analyze the role of BHCs’ size and capital and the impact of the global financial crisis on the relationship between derivatives and risks.

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Vorheriges Kapitel Introduction

Nächstes Kapitel Quality of Bank Capital and Bank Lending Behaviour During the Global Financial Crisis

FRB of Chicago, holding company data, https://www.chicagofed.org/applications/bhc_data/bhcdata_index.cfm.

In addition, the adverse selection problem may also be present. A bank may want to buy credit protection against the borrowers it perceives as most risky. This is aligned with empirical evidence from Dahiya et al. (2003) that identifies a significant negative stock price reaction for a borrower when a bank announces that the borrower’s loan is to be sold. Dewally and Shao (2012) find that the use of financial derivatives by BHCs increases their opacity.

See Ahmed et al. (2011) for further description of SFAS 133 and detailed comparison with previous accounting standards SFAS 52 and SFAS 80, including the impact of the accounting change on the hedging effectiveness of derivatives.

Our analysis may relate to the scant literature on regulatory compliance. Bajo et al. (2009) find that family firms and firms with an established corporate ethos comply with regulations more often than others. Considering that family firms are typically small, we anticipate that the smaller size of a BHC might better support regulatory compliance in classification of financial derivatives.

Géczy et al. (1997) show that corporations use exchange rate derivatives to mitigate cash flow variations, so that they are able to exploit profitable growth opportunities. For further determinants of corporate hedging, see Nance et al. (1993) and Mian (1996).

These data are available at: https://www.chicagofed.org/applications/bhc_data/bhcdata_index.cfm.

These data are available at: http://www.federalreserve.gov/econresdata/default.htm.

Our decomposition is consistent with the classification of Sections 165 and 166 of the Dodd–Frank Act, in which BHCs with $50 billion or more in consolidated assets are automatically considered to be systemically important institutions [Dodd–Frank Wall Street Reform and Consumer Protection Act and Independent Commission on Banking (2011)]. See also http://www.federalreserve.gov/newsevents/testimony/gibson20120516a.htm.

The nominal broad dollar index is a weighted average of the foreign exchange value of the U.S. dollar against the currencies of a broad group of major U.S. trading partners. Weights for the broad index can be found at http://www.federalreserve.gov/releases/H10/Weights. For more information on exchange rate indexes for the U.S. dollar, see “Indexes of the Foreign Exchange Value of the Dollar,” Federal Reserve Bulletin, 91:1 (Winter 2005), pp. 1–8 (http://www.federalreserve.gov/pubs/bulletin/2005/winter05_index.pdf).

The SUR regression has been employed in recent studies by Viale et al. (2009), Yong et al. (2009), Ammer et al. (2010), Białkowski et al. (2012), and Lim et al. (2012).

A number of BHCs drop out of the sample because of mergers and failures during our sample period.

The Hausman test indicates that a fixed effects model should be used rather than a random effects model.

Berger and Bouwman (2013) use corporate income tax rates as an instrument for the level of bank capital.

In Appendix A Table A.1, we report the diagnostic tests of instruments used in IV regression.

To ensure that interest rate, foreign exchange, and credit exposures are significantly related to financial derivatives and uncorrelated with the risk betas, we have taken the following approach in Table 2.8. In Panel A, the interest rate derivatives are instrumented with foreign exchange and credit exposures. In Panel B, the exchange rate derivatives are instrumented with interest rate and credit exposures. In Panel C, the credit derivatives are instrumented with interest rate and foreign exchange exposures.

Bank regulatory reports separate financial derivatives (interest rate, foreign exchange, commodity, and equity derivatives) held for trading purposes and for purposes other than trading, but do not separately report credit derivatives held for trading and for hedging purposes. Hence, similar to Minton et al. (2009) and Hirtle (2009), we use net credit protection bought, which is the difference between the notional principal of credit derivatives on which the bank is a beneficiary (Credit Protection Bought) and the notional principal amount of credit derivatives on which the bank is a guarantor (Credit Protection Sold) as a measure of the extent to which BHCs use credit derivatives to hedge credit risk.

We also included the dummy variable SIFI in the regression, but it was dropped from the model due to collinearity.

To assess the reliability of our results, we conducted several robustness checks. We used the change in the difference between BBB bond yield and the risk-free rate in the first-stage regression as an alternative definition of Credit Risk. In addition, we used several different instrument variables in our estimations. Our findings are qualitatively robust compared to alternative specifications. The robustness checks results can be found in Appendix A from Table A.2 to Table A.10.

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Titel: The Use of Financial Derivatives and Risks of U.S. Bank Holding Companies
verfasst von: Shaofang Li
Verlag: Springer Singapore
Buch: Financial Institutions in the Global Financial Crisis
Print ISBN: 978-981-10-7439-4

Electronic ISBN: 978-981-10-7440-0

Copyright-Jahr: 2018
DOI: https://doi.org/10.1007/978-981-10-7440-0_2