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Derivatives Activity at Troubled Banks

Author

Listed:
  • 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.

Suggested Citation

  • Joe Peek & Eric S. Rosengren, 1996. "Derivatives Activity at Troubled Banks," Boston College Working Papers in Economics 358, Boston College Department of Economics.
  • Handle: RePEc:boc:bocoec:358
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    File URL: http://fmwww.bc.edu/EC-P/wp358.pdf
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    References listed on IDEAS

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    Cited by:

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    2. 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 04/217, Ghent University, Faculty of Economics and Business Administration.
    3. Helwege, Jean, 2010. "Financial firm bankruptcy and systemic risk," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 20(1), pages 1-12, February.
    4. Chiara Oldani, 2005. "An Overview of the Literature about Derivatives," Macroeconomics 0504004, University Library of Munich, Germany.
    5. Leslie Hodder & Mark Kohlbeck & Mary Lea McAnally, 2002. "Accounting Choices and Risk Management: SFAS No. 115 and U.S. Bank Holding Companies," Contemporary Accounting Research, John Wiley & Sons, vol. 19(2), pages 225-270, June.
    6. Jad Bazih & Dieter Vanwalleghem, 2021. "Deriving value or risk? Determinants and the impact of emerging market banks’ derivative usage," Post-Print hal-03329217, HAL.
    7. Brock, W.A. & Hommes, C.H. & Wagener, F.O.O., 2009. "More hedging instruments may destabilize markets," Journal of Economic Dynamics and Control, Elsevier, vol. 33(11), pages 1912-1928, November.
    8. 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 04/264, Ghent University, Faculty of Economics and Business Administration.
    9. Chuang-Chang Chang & Keng-Yu Ho & Yu-Jen Hsiao, 2018. "Derivatives usage for banking industry: evidence from the European markets," Review of Quantitative Finance and Accounting, Springer, vol. 51(4), pages 921-941, November.
    10. Mr. Joshua Charap & Jelena Pavlovic, 2009. "Development of the Commercial Banking System in Afghanistan: Risks and Rewards," IMF Working Papers 2009/150, International Monetary Fund.

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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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