The Effect of Bank-Held Derivatives on Credit Accessibility

Abstract

Since 1985 commercial banks have become active participants in the interest-rate derivative products markets either as end-users or as intermediaries or as both. Over this same period significant changes were made in the composition of bank portfolios. This paper investigates the relationship between the lending activities of individual banks and their participation in the interest-rate derivative markets. Banks which utilized over-the-counter (OTC) interest-rate swaps experienced greater growth in their commercial and industrial (C&I) loan portfolios than banks which did not use these financial instruments. This result is consistent with the model of Diamond (1984) which predicts that intermediaries' use of derivatives enables increased reliance on their comparative advantage as delegated monitors. Consistent with banks viewing loans and securities as substitutable assets, we also find that securities portfolio growth is negatively related to banks' use of OTC swaps. By contrast, the use of futures is associated with no change in C&I loan growth and a positive change in securities portfolio growth, suggesting futures contracts allow banks to better manage the interest-risk exposures in their securities portfolios.

JEL Classification: G13, G21