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. commer cial banks with total assets between $100 million and $1 billion. These ban ks are interesting, because they allow us to focus on the end-users of inte rest-rate derivatives rather than dealers. Over our four-year test period, 1990-1993, only 10% of these large community banks, on average about 250 ba nks per year, used any interest-rate derivatives. We find evidence that the use of interest-rate derivatives is positively related to exposure to inte rest-rate risk as measured by the absolute value of the 12-month maturity g ap. In addition, a community bank's decision to participate in interest-rat e contracts is positively related to size. Nevertheless, we find no positiv e relationship between size and the extent of participation in the derivati ves market. Finally, our evidence suggests that banks that participate more heavily in interest-rate swaps have stronger capital positions, an indicat or of market or regulatory discipline or both.