This paper explores the extent to which interest risk exposure is priced in bank margins.Our contribution to the literature is twofold: First, we present an extended model of Ho and Saunders (1981) that explicitly captures interest rate risk and returns from maturity transformation. Banks price interest risk according to their individual exposure separately in loan and deposit rates, but reduce these charges when they expect returns from maturity transformation. Second, using a comprehensive dataset covering the German universal banks between 2000 and 2009, we test the model-implied hypotheses not only for the commonly investigated net interest income, but additionally for interest income and expenses separately.Controlling for earnings from bank-individual maturity transformation strategies, we find all banks to charge additional fees for macroeconomic interest volatility exposure. Microeco- Non-technical summaryBanks are intermediaries between investors and entrepreneurs. They transform long-term, illiquid and risky loans into safe deposits that are due within short notice. By doing so, they take risks, for which they are remunerated. Besides, they can generate income by making use of their market power and by setting their credit and deposit conditions accordingly. In a theoretical model, we show that the bank rates are set in accordance with the costs and earnings caused by the loans and deposits. In addition, banks levy premia for credit and interest rate risk, and for the access to the capital market. We derive the following empirically testable hypotheses:The margins on the asset side should be the higher, the stronger the market power, the more volatile the interest rates and the credit risk and the greater the exposure to interest rate risk.The model also predicts that banks smooth their interest rates (relative to the interest rates observed on the capital market). Accordingly, on the liability side, we expect the same factors to have an impact, expect for the credit risk, which is here not relevant. In an empirical study of all German universal banks for the period 2000 -2009, we obtain the following results:1. The statements derived from the theoretical model can be confirmed in our study, in particular we find that the higher the market power the higher the interest income margin and the lower the interest expense margin.2. The interest rate margins increase for all banks, in the event that the interest rates become more volatile. Additionally, for banks from the savings and credit cooperative sectors, we see the smoothing of bank rates that is predicted by the theoretical model. Nichttechnische Zusammenfassung

This paper explores the extent to which interest risk exposure is priced in bank margins.Our contribution to the literature is twofold: First, we present an extended model of Ho and Saunders (1981) that explicitly captures interest rate risk and returns from maturity transformation. Banks price interest risk according to their individual exposure separately in loan and deposit rates, but reduce these charges when they expect returns from maturity transformation. Second, using a comprehensive dataset covering the German universal banks between 2000 and 2009, we test the model-implied hypotheses not only for the commonly investigated net interest income, but additionally for interest income and expenses separately.Controlling for earnings from bank-individual maturity transformation strategies, we find all banks to charge additional fees for macroeconomic interest volatility exposure. Microeco- Non-technical summaryBanks are intermediaries between investors and entrepreneurs. They transform long-term, illiquid and risky loans into safe deposits that are due within short notice. By doing so, they take risks, for which they are remunerated. Besides, they can generate income by making use of their market power and by setting their credit and deposit conditions accordingly. In a theoretical model, we show that the bank rates are set in accordance with the costs and earnings caused by the loans and deposits. In addition, banks levy premia for credit and interest rate risk, and for the access to the capital market. We derive the following empirically testable hypotheses:The margins on the asset side should be the higher, the stronger the market power, the more volatile the interest rates and the credit risk and the greater the exposure to interest rate risk.The model also predicts that banks smooth their interest rates (relative to the interest rates observed on the capital market). Accordingly, on the liability side, we expect the same factors to have an impact, expect for the credit risk, which is here not relevant. In an empirical study of all German universal banks for the period 2000 -2009, we obtain the following results:1. The statements derived from the theoretical model can be confirmed in our study, in particular we find that the higher the market power the higher the interest income margin and the lower the interest expense margin.2. The interest rate margins increase for all banks, in the event that the interest rates become more volatile. Additionally, for banks from the savings and credit cooperative sectors, we see the smoothing of bank rates that is predicted by the theoretical model. Nichttechnische Zusammenfassung

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Evidence from the Banking Industry Terms of use: Documents in AbstractWe investigate financial intermediaries' interest rate risk management as the simultaneous decision of on-balance-sheet exposure and interest rate swap use. Our findings show that both decisions are substitute risk management strategies. Hausman exogeneity tests indicate that both decisions are only endogenous to one another for banks that start using swaps for the first time. For other banks, the maturity gap is exogenous to the decision to use swaps, but the reverse relationship is endogenous. For banks with trading activity, both decisions are exogenous to one another. We interpret these findings as the maturity gap being largely determined by customer liquidity needs, whereas the decision to use swaps relies on compliance with the interest rate risk regulation. Although hedging motives dominate, we find selective hedging behavior in swap use driven by the slope of the yield curve as well as by funding uncertainty.

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Information on all of the papers published in the ECB Working Paper Series can be found on the ECB's website, http://www.ecb. europa.eu/pub/scientific/wps/date/html/index.en.html Household Finance and Consumption NetworkThis paper contains research conducted within the Household Finance and Consumption Network (HFCN). The HFCN consists of survey specialists, statisticians and economists from the ECB, the national central banks of the Eurosystem and a number of national statistical institutes.The HFCN is chaired by Gabriel Fagan (ECB) and Carlos Sánchez Muñoz (ECB).