Derivatives Activity at Troubled Banks

96-52

39 Pages Posted: 7 Oct 2015

See all articles by Joe Peek

Joe Peek

Federal Reserve Banks - Federal Reserve Bank of Boston

Eric S. Rosengren

Federal Reserve Bank of Boston - Supervision and Regulation

Date Written: November 1996

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.

JEL Classification: G28, G21

Suggested Citation

Peek, Joe and Rosengren, Eric S., Derivatives Activity at Troubled Banks (November 1996). 96-52. Available at SSRN: https://ssrn.com/abstract=886 or http://dx.doi.org/10.2139/ssrn.886

Joe Peek

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

Eric S. Rosengren (Contact Author)

Federal Reserve Bank of Boston - Supervision and Regulation ( email )

600 Atlantic Avenue
P.O. Box 2076
Boston, MA 02210
United States
617-973-3090 (Phone)
617-973-3219 (Fax)

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