Who's Capitalizing on Derivatives?
FINANCIAL INDUSTRY STUDIES, July 1995
Posted: 23 Aug 1998
Are banks using derivatives to hedge financial risks or to make speculative gambles? While data are not available to answer this question fully and directly, the relationship between bank capital and derivatives activities may provide an important clue. This study provides evidence that those banks with the highest capital cushion with which to absorb losses and potentially the lowest risk-taking incentives are the ones with the highest derivatives participation. This finding is consistent with the view that either financially strong institutions are using derivatives to hedge, or regulatory and market discipline have made higher capital levels a prerequisite for derivatives activities. Either way, a positive relationship between derivatives activities and capitalization should help ease concerns regarding bank derivatives activities.
JEL Classification: G21, G28
Suggested Citation: Suggested Citation