Working Paper: NBER ID: w31166
Authors: Lihong McPhail; Philipp Schnabl; Bruce Tuckman
Abstract: We analyze whether banks use interest rate swaps to hedge the interest rate risk of their assets, primarily loans and securities. By examining regulatory data on individual swap positions from the largest 250 U.S. banks, we find that banks hold large swap positions with an average notional value of $434 billion. However, after accounting for offsetting swap positions, the average bank exhibits almost no net interest rate risk from swaps: a 100-basis-point increase in rates reduces the value of its swaps by only 0.1% of bank equity. The variation in swap positions across banks indicates that banks use swaps to hedge interest rate risk, thereby facilitating risk transfer within the banking sector. Additionally, we find that swap dealer banks primarily hold swap positions for market making, while non-dealer banks use swaps to meet borrower demand for fixed-rate loans. Despite the substantial notional amounts, our findings suggest that swap positions are not economically significant in hedging the overall interest rate risk of bank assets. Instead, banks primarily rely on their deposit franchise to hedge interest rate risk.
Keywords: Interest Rate Swaps; Hedging; Interest Rate Risk; Banks
JEL Codes: G21; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Banks' use of interest rate swaps (G21) | Negligible net interest rate risk (E43) |
| 100-basis-point increase in rates (E43) | Increases value of swaps by 0.1% of equity on average (G12) |
| Banks' swap positions are large (G21) | Economic significance in hedging interest rate risk is minimal (G19) |
| Banks rely more on their deposit franchise (G21) | Managing long-term asset holdings (G32) |
| Notional amount of swaps is substantial (G15) | DV01 for the average U.S. bank is only $3 million (G21) |
| Average DV01 values for swap dealers being around 0.01% of bank equity (G12) | Lack of significant exposure holds true for both swap dealers and non-swap dealers (G28) |