Variable-rate loan commitments, deposit withdrawal risk, and anticipatory hedging
✍ Scribed by G. D. Koppenhaver
- Book ID
- 102843847
- Publisher
- John Wiley and Sons
- Year
- 1985
- Tongue
- English
- Weight
- 946 KB
- Volume
- 5
- Category
- Article
- ISSN
- 0270-7314
No coin nor oath required. For personal study only.
✦ Synopsis
he obvious elements in a bank's balance sheet that can benefit from the risk-T shifting possibilities of financial futures trading are nonloan assets such as _ _ government securities, or variable-rate deposits such as money market accounts (see Ciccehetti et al., 1981;Ederington, 1979;Franckle, 1980;Parker and Daigler, 1981). Less research exists on the usefulness of financial futures contracts in commercial lending operations (for exceptions, see B a t h , 1983; Dew and Martell, 1981;Koppenhaver, 1983). In the only other published theory on loan commitments and financial futures, Ho and Saunders (1983) develop a model to determine a hedge of fixed-rate commitment takedowns when funding costs are subject to interestrate risk. In contrast, this article shows that financial futures contracts can help manage the interest rate and takedown uncertainty associated with making variablerate loan commitments when deposits are subject to withdrawal risk. The results of this investigation are that the anticipatoiy hedge of interest rate and quantity risks will be greater: (1) the greater the expected fall in interest rates, (2) the more ineiastic the demand for credit by borrowers, and (3) the smaller the problem of disintermediation. Using alternative assumptions about the formation of expectations and t h e risk aversion of bank management, a simulation of the optimal futures trading strategy using bank data from the Seventh Federal Reserve District indicates that up to 10% of the variability of unhedged profits could be eliminated by T-bill futures hedging.
There are two general types of loan commitments used in practice: fixed-rate and variable-rate. In a fixed-rate loan commitment the lender provides credit on demand up to some previously determined quantity at a constant, known interest rate. In a variahle-rate loan commitment the lender provides future credit on demand up to some niaximum quantity at a price determined by a previously specified formula