Joseph F. Sinkey

Evidence on the financial characteristics of banks that do and do not use derivatives

Abstract While the use of derivatives by U.S. commercial banks has exploded in recent years, the growth has not been evenly distributed. At present, only about five percent of banks are involved in the market for derivatives. Although the concentration of derivatives activities in the largest banks is well known, we know less about other factors underlying a bank’s decision to use derivatives. This article investigates the financial characteristics of banks that use derivatives and those that do not. We find that user banks, compared to nonusers, are associated with riskier capital structures (more notes and debentures and less equity capital), larger maturity mismatches between assets and liabilities, greater net loan charge-offs, and lower net interest margins. We also find that banks, especially smaller ones, benefit from being associated with bank-holding companies. Finally, our evidence does not support a regulatory hypothesis in which banks must have stronger capital positions to engage in derivative activities. JEL Classification : G21, G28, G32

The Use of Interest Rate Derivatives by End-users: The Case of Large Community Banks

This paper investigates the use of interest-rate derivatives by U.S. commercial banks with total assets between

On competition, risk, and hidden assets in the market for bank credit cards

100 million and

The Relationship Between Corporate Compensation Policies and Investment Opportunities: Empirical Evidence for Large Bank Holding Companies

1 billion. These banks are interesting, because they allow us to focus on the end-users of interest-rate derivatives rather than dealers. Over our four-year test period, 1990–1993, only 10% of these large community banks, on average about 250 banks per year, used any interest-rate derivatives. We find evidence that the use of interest-rate derivatives is positively related to exposure to interest-rate risk as measured by the absolute value of the 12-month maturity gap. In addition, a community banks decision to participate in interest-rate contracts is positively related to size. Nevertheless, we find no positive relationship between size and the extent of participation in the derivatives market. Finally, our evidence suggests that banks that participate more heavily in interest-rate swaps have stronger capital positions, an indicator of market or regulatory discipline or both.

The reaction of bank stock prices to news of derivatives losses by corporate clients

Abstract The market for credit cards has been the subject of recent attention and controversy because of ‘high’ profits earned on credit cards and substantial premiums on the resale of credit-card receivables. This paper estimates risk—return profiles for credit-card banks and explores the role of intangible assets in determining resale premiums on credit-card receivables. In addition, the effects on the resale market of securitization and the opportunity cost of acquiring new accounts are analyzed. Using alternative measures of risk and alternative control groups, we find, for the years 1989 to 1995, that credit-card banks earned significantly higher returns on assets but that these returns were associated with greater risk-taking. Analysis of premia for the years 1993 to 1995 suggest that acquiring banks pay higher premia for mid-sized regional accounts than for larger, national portfolios, perhaps because of richer cross-selling opportunities.

Financial Innovation, Investment Opportunities, and Corporate Policy Choices for Large Bank Holding Companies

This paper investigates whether the firms set of investment opportunities drives the amount and type of executive compensation by conducting a detailed empirical analysis of the executive compensation plans of large bank holding companies. We examine intra-industry changes in compensation policy over a period of significant change in the investment-opportunity set, 1979 to 1985. Our empirical findings reveal that total real compensation and the ratio of incentive compensation-to-total compensation increased substantially at regional bank holding companies but remained stable at money-center bank holding companies. These results are consistent with the hypothesis that during the early 1980s financial innovation and deregulation created greater growth opportunities for regional bank holding companies than for money-center bank holding companies.

The Use of Warrants in the Bail out of First Pennsylvania Bank: An Application of Option Pricing

Abstract From March through May of 1994, several large nonfinancial firms announced millions of dollars in losses from derivatives deals, especially those arranged by Bankers Trust. Accompanying these announcements and related news stories were allegations that Bankers Trust had either misrepresented, lied, or deceived its clients. Using SUR methods, we investigate how these announcements affected Bankers Trust and three portfolios of banks: dealers, nondealers, and nonusers. Our results indicate significant cumulative abnormal returns of −12.14% (Bankers Trust), −5.56% (13 dealer banks), and −2.45% (32 nondealer, user banks). The evidence suggests an intra-industry, information-transfer effect consistent with rational pricing. The replacement cost of derivative contracts is an important factor in explaining the variation in abnormal returns across banks.