The Park Place Economist


Derivatives, namely, futures, options and swaps, are off-balance sheet instruments that allow banks to transform the duration of their balance sheets in order to manage market risk without incurring additional capital requirements. Banks’ use of derivatives has been growing rapidly in recent years due, in part, to regulatory changes concerning the amount of capital banks are required to hold as well as an increase in market risk exposure. The increasing popularity of financial derivatives has brought about much concern regarding the potential risks and complexities involved in derivative trading. This paper will explore the determinants of the use of such instruments by commercial banks to ascertain whether they increase or decrease banks’ exposure to risk.