The Relationship Between Large Banks Investment In Available-For-Sale Securities And The Interest Rate Risk Of Their Securities

Abstract

This study presents an empirical examination of the relationship between large banks' investment in available-for-sale securities (AFS) and the interest rate risk of their securities. It concentrates on the years, 1997-2000, when  Held-to-maturity (HTM) Securities -Debt securities that management has the positive intent and ability to hold to maturity.  Trading Securities -Debt and equity securities purchased with the intent to sell in the near term.  Available-for-sale (AFS) Securities -Debt and equity securities not classified as either HTM or Trading securities.The accounting for HTM securities is based on the principle of historical cost: unrealized holding gains and losses are not recognized. In the case of Trading and AFS securities, the accounting is based on fair value (usually the market price). Unrealized holding gains and losses are recorded in income for trading securities and in equity for AFS securities. Barth et al. (1995) found significant increases in the volatility of bank capital under fair value accounting of securities. Because capital ratio is an accepted stability measure in the banking industry, unrealized losses on AFS securities included in capital may signal safety and soundness problems. This could have an adverse effect on regulators and depositors.Previous studies (Ernst and Young, 1993, 1994;Razaee and Lee, 1995, Beatty, 1995) found that managers planned and reduced the maturity of the portfolio in 1993 and 1994, before and immediately after the implementation of SFAS 115. According to Beatty (1995), shortening the maturity of securities may have an