Abstract
In this paper, we examine the impact of interest rate risk factors on the interest rate derivatives (IRD) usage by commercial banks in India. We focus our analysis during the period 2008-2010. We have taken this period to highlight that during and after global financial crisis, what were the main factors that influence the interest rate derivatives usage by Indian commercial banks. We have used simulation analysis and regression analysis to identify the interest rate risk factors. Using Tobit fixed effect analysis, we are able to provide empirical evidence that interest rate risk drives the derivatives usages by Indian commercial banks. Our results indicate that asset size, the impact of interest rate shock on equity capital are positively related to use of derivatives for hedging as well as trading and interest rate sensitivity factor is negatively related to the use of derivatives for hedging and trading. New generation private banks have relatively large exposure to derivatives for trading purpose.
Highlights
Interest rate risk is one of the core risks in banking books that banks have to accept and take the profit out of them
We examine the impact of interest rate risk factors on the interest rate derivatives (IRD) usage by commercial banks in India
Since July 1999 RBI allowed Scheduled Commercial Banks, Primary Dealers (PDs) and Financial Institutions to use Interest Rate Swaps (IRS) and Forward Rate Agreements (FRAs) to mitigate the impact of interest rate changes on their asset and liability streams through their own asset liability management (ALM) or for market making i.e. risk trading purposes
Summary
Interest rate risk is one of the core risks in banking books that banks have to accept and take the profit out of them. Banks generally deals in derivatives for balance sheet management and market making purposes where the bank offers derivatives services to its customers to hedge their risks. Indian banks are having exposure to interest rate derivatives and currency derivatives for both hedging as well as trading purposes. Since July 1999 RBI allowed Scheduled Commercial Banks, Primary Dealers (PDs) and Financial Institutions to use Interest Rate Swaps (IRS) and Forward Rate Agreements (FRAs) to mitigate the impact of interest rate changes on their asset and liability streams through their own asset liability management (ALM) or for market making i.e. risk trading purposes. This paper attempts to test the important interest rate risk factors as possible determinants of interest rate derivatives usage for both hedging and trading purposes in banks.
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