Interest rate derivatives at commercial banks: An empirical investigation

I analyze the effects of bank characteristics and macroeconomic shocks on interest rate riskmanagement behavior of commercial banks. My findings are consistent with hedging theories based on cost of financial distress and costly external financing. Banks with higher probability of financial distress manage their interest rate risk more aggressively, both by means of on-balance sheet and offbalance sheet instruments. As compared to the derivative users, the derivative non-user banks adopt conservative asset–liability management policies in tighter monetary policy regimes. Finally, I show that the derivative non-user bank’s lending volume declines significantly with the contraction in the money supply. Derivative users, on the other hand, remain immune to the monetary policy shocksMy findings suggest that a potential benefit of derivatives usage is to minimize the effect of external shocks on a firm’s operating policies. r 2006 Elsevier B.V. All rights reserved