Derivatives Holdings and Systemic Risk in the U.S. Banking Sector

Abstract

This paper studies the impact of the banks' portfolio holdings of financial derivatives on the banks' individual contribution to systemic risk over and above the effect of variables related to size, interconnectedness, substitutability, and other balance sheet information. Using a sample of 91 U.S. bank holding companies from 2002 to 2011, we compare five measures of the banks' contribution to systemic risk and find that the new measure proposed in this study, Net Shapley Value, outperforms the others. Using this measure we find that the banks' holdings of foreign exchange and credit derivatives increase the banks contributions to systemic risk whereas holdings of interest rate derivatives decrease it. Nevertheless, the proportion of non-performing loans over total loans and the leverage ratio have much stronger impact on systemic risk than derivatives holdings. We find that before the subprime crisis credit derivatives decreased systemic risk whereas during the crisis increased it. So, credit derivatives seemed to change their role from shock absorbers to shock issuers. This effect is not observed in the other types of derivatives. María Rodríguez-Moreno Derivatives Holdings and Systemic Risk in the U.S. Banking SectorAbstract This paper studies the impact of the banks' portfolio holdings of financial derivatives on the banks' individual contribution to systemic risk over and above the effect of variables related to size, interconnectedness, substitutability, and other balance sheet information.Using a sample of 91 U.S. bank holding companies from 2002 to 2011, we compare five measures of the banks' contribution to systemic risk and find that the new measure proposed in this study, Net Shapley Value, outperforms the others. Using this measure we find that the banks' holdings of foreign exchange and credit derivatives increase the banks contributions to systemic risk whereas holdings of interest rate derivatives decrease it. Nevertheless, the proportion of non-performing loans over total loans and the leverage ratio have much stronger impact on systemic risk than derivatives holdings.We find that before the subprime crisis credit derivatives decreased systemic risk whereas during the crisis increased it. So, credit derivatives seemed to change their role from shock absorbers to shock issuers. This effect is not observed in the other types of derivatives.

Liquidity commonalities in the corporate CDS market around the 2007–2012 financial crisis

“…This result reinforces the role played by the CDS around the Lehman's collapse as shock issuers (see Rodriguez-Moreno et al, 2012) and suggests a lower effect of this market around the Greek episode.…”

“…The fact that the main participants in the CDS market are systemically important financial 3 institutions (SIFIs) facilitates that any shock affecting credit derivatives could revert directly on these institutions and could have implications in terms of financial stability. In this line, Rodriguez-Moreno et al (2012) show that the holdings of credit derivatives by U.S. banks affected their contributions to systemic risk, such that these derivatives behaved as shock absorbers before the financial crisis but changed their role to shock issuers during the crisis. It is worth mentioning that the liquidity risk derived from the typology of the banks participating in the CDS market could be exacerbated by the high degree of concentration of the market activity in the hands of a few SIFIs acting as market participants.…”

Credit Cycles, Securitization, and Credit Default Swaps

“…Summing up, although some theoretical papers predict trading in CDS may increase financial instability, in the best of our knowledge, is scarce empirical evidence on the actual impact of CDSs on financial stability, economic growth, and systemic risk. Rodriguez-Moreno, et al (2014) report , before the subprime crisis, holdings of credit derivatives by U.S. banks decreased systemic risk. However, after the crisis, these holdings increased banks' systemic risk.…”

SVAR and NLS Model Analysis of US Bank Financial Derivatives and the Related Fields Based on Their Statistical Data

“…(9), its gross national product per capita for US will rise rapidly with the increase in other derivatives trading and then gradually enter into a stage of slowly growth when the notional amount of other derivatives trading is more than $1590 billion or its GNP per capita is above $44,000. Therefore, for US banks, more commodities and equities derivatives trading aren't the better [12]. There is non-linear relationship between them as shown in Fig.…”