We explore one channel through which interest-rate derivatives usage affects loan growth positively in bank holding companies (BHCs). If interest-rate derivatives usage allows a BHC to substitute more freely among sources of funds, then its reliance on less interest-rate-sensitive sources such as core deposits should be lower. We test the hypothesis that if BHCs use interest-rate derivatives to reduce the adverse effects of interest-rate uncertainty on lending, then their loan growth should be less sensitive to core deposit growth. We find that loan growth is less sensitive to core deposit growth for interest-rate derivatives users than for non-users and that this sensitivity is lower when the extent of derivatives usage is higher. One important implication is that the funding flexibility enjoyed by BHCs using interest-rate derivatives should allow these BHCs to provide a smoother and higher level of intermediation, leading to more stable loan growth and greater economic stability.

Price–concentration studies in banking typically find a significant and negative relationship between consumer deposit rates (i.e., prices) and market concentration. This implies highly concentrated banking markets are “bad” for depositors. It also provides support for the Structure-Conduct-Performance hypothesis and rejects the Efficient-Structure hypothesis. However, these studies have focused almost exclusively on supply-side control variables and neglected demand-side variables when estimating the reduced form price–concentration relationship. For example, previous studies have not included in their analysis bank-specific risk variables as measures of cross-sectional derived deposit demand. We find that when bank-specific risk variables are included in the analysis the magnitude of the relationship between deposit rates and market concentration decreases by over 50%. We offer an explanation for these results based on the correlation between a bank’s risk profile and the structure of the market in which it operates. These results suggest that it may be necessary to reconsider the well-established assumption that higher market concentration necessarily leads to anticompetitive deposit pricing behavior by commercial banks. This has direct implications for the antitrust evaluations of bank merger and acquisition proposals by regulatory agencies. And, in a more general sense, these results suggest that any Structure-Conduct-Performance based study that does not explicitly consider the possibility of very different risk profiles of the firms analyzed may indeed miss a very important set of explanatory variables. And, thus, the results from those studies may be spurious.

We study the relationship between bank participation in derivatives contracting and bank lending for the period 30 June 1985 through the end of 1992. Since 1985 commercial banks have become active participants in the interest-rate derivative products markets as end-users, or intermediaries, or both. Over much of this period significant changes were made in the composition of bank portfolios. We find that banks using interest-rate derivatives experience greater growth in their commercial and industrial (C&I) loan portfolios than banks that do not use these financial instruments. This result is consistent with the model of Diamond (Review of Economic Studies 51, 1984, 393–414) which predicts that intermediaries' use of derivatives enables increased reliance on their comparative advantage as delegated monitors.