Banks' option to lend, interest rate sensitivity, and credit availability

Iftekhar Hasan and Sarkar Sudipto

No 15/2002, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: Interest rate risk is a major concern for banks because of the nominal nature of their assets and the asset-liability maturity mismatch.This paper proposes a new way to derive a bank's interest rate sensitivity, by examining separately the effects of interest rate changes on existing loans (loans-in-place) and potential loans (loans-in-process).A potential loan is shown to be equivalent to an American option to lend, and is valued using option theory.An increase in interest rates usually has a negative effect on existing loans.However, if both deposit and lending rates rise by the same amount, the value of a potential loan generally increases. Hence a bank's lending slack (ratio of loans-in-process to loans-in-place) will determine its overall interest rate risk. Empirical evidence indicates that low-slack banks indeed have significantly more interest rate risk than high-slack banks.The model also makes predictions regarding the effect of deposit and lending rate parameters on bank credit availability.Empirical tests with quarterly data are generally supportive of these predictions.

Keywords: interest rate risk; option to lend; bank's lending capacity; maturity intermediation (search for similar items in EconPapers)
Date: 2002
References: Add references at CitEc
Citations:

Downloads: (external link)
https://www.econstor.eu/bitstream/10419/211919/1/bof-rdp2002-015.pdf (application/pdf)

Related works:
Journal Article: Banks' option to lend, interest rate sensitivity, and credit availability (2002)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofrdp:rdp2002_015

Access Statistics for this paper

More papers in Bank of Finland Research Discussion Papers from Bank of Finland Contact information at EDIRC.
Bibliographic data for series maintained by ZBW - Leibniz Information Centre for Economics ().