The dynamic shift in banking services from traditional lending and receiving deposits to risk intermediation has exposed banks to huge macroeconomic risk and demands continuous risk assessment of its activities. At present, with the signalling of another build-up in leverage and high asset prices in the world, the banking sector could result in a toxic mix that would lead to one more global uncertainty. The decision of merger in Indian banking industry might result in another source of build-up of leverage since the number of India’s public sector banks drops to 12 from 27 earlier. This raises question on what can help banks to diversify its risk exposure raised through the consolidated leverage, deposits, assets, massive NPAs, huge off-balance sheet risk exposure, forex reserves, etc.?
By nature, banking sector is the product of ‘time value of money’. Hence, linked to everything happens in the world. Risk is defined by the uncertainty that has adverse consequences on earnings or wealth, or the uncertainty associated with negative outcomes. Bank risk exposure is the extent to which a bank could be affected by certain factors that may have a negative impact on its earnings and operations. Hence, risk exposure can be predicted taking the three major concepts namely the earnings, wealth and negative outcomes. Needless to say, the earnings and wealth represent the financial stability, performance level and the efficiency of banks in general.
Out of various methods of managing financial risks, banks predominantly control them through hedging and speculating on derivatives. Financial derivatives, including currency, interest rate, and commodity derivatives, are one among the means for managing risks in financial institutions. In turn, derivatives have their own impact on the bank characteristics including its performance, risk exposure, efficiency and stability. Hence, there is a question of examining their hedge and speculative goals such that the anomalies arising out of financial intermediation namely stability and efficiency are not compromised.
The literature of corporate risk management includes empirical examination taking any one of the above mentioned research problems as their study variable. The systematic literature review conducted by the authors revealed the ‘moderating role of derivatives’ to be the major gap yet to be studied on this area. The current study aims to model the bank risk exposure through derivatives in the Indian banking scenario. Therefore, “examining the moderating effect of derivatives between bank risk exposure and anomalies of financial intermediation (impact on stability, efficiency and market value)’ has been identified to be the gap for further research.
The foreseen implications are as follows:
1. The clarity on the role of derivative portfolios (moderator) based on its purpose would help banks and bank regulators in understanding the market behaviour of these portfolios.
2. The results of the study would help banks choose the derivative portfolios based on their need and value impact.
3. The results and the conceptual model might form part of an extended contribution of thoughts in the existing literature