Market Timing, Maturity Mismatch, and Risk Management: Evidence from the Banking Industry

Abstract

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.

Banks’ Interest Rate Risk and Search for Yield: A Theoretical Rationale and Some Empirical Evidence

“…Borio et al (2015) report evidence for particularly decreased bank profitability as a result of particularly low interest rates and a particularly flat yield curve. Furthermore, a decreased profitability of classic lending business may also be due to a smaller margin contribution from deposits as a result of lower short-term rates as the findings of Busch and Memmel (2015) and Ruprecht et al (2013) suggest. short-term rates, which are generally associated with a steeper yield curve, lead to increased credit risk-taking by banks.…”

“…Memmel (), Memmel and Schertler () and Ruprecht et al . () study data from interest rate risk and annual account reporting from Germany with the overall result that a flatter yield curve, implying a lower expected return from interest rate risk, leads to a decreased taking of this risk by banks. Our paper refines the findings of these studies by establishing a general potential link between lower expected return from interest rate risk and increased taking of this risk.…”

“…Furthermore, a decreased profitability of classic lending business may also be due to a smaller margin contribution from deposits as a result of lower short‐term rates as the findings of Busch and Memmel () and Ruprecht et al . () suggest.…”

“… See also Ruprecht et al . (), who find that banks with trading book differ from banks without trading book with respect to their behavior towards interest rate risk. …”

Implied Maturity Mismatches and Investor Disagreement

“…Purnanandam (2007) finds that U.S. banks intensify hedging of on-balance sheet exposure with interest rate derivative contracts once their probability of default increases. Ruprecht et al (2013) model the simultaneous choice of an on-balance duration gap and off-balance interest rate swap use of German banks. They find that higher bankruptcy risk induces banks to reduce MM and increase the propensity to hedge this gap with interest rate swaps.…”