Effects of derivatives usage and financial statement items on capital market risk measures of Bank stocks: evidence from India

Abstract

This paper examines the impact of off-balance sheet derivatives usage by banks combined with financial statement items on their capital market risk measures. Financial markets liberalization policies in the 1990s, led to a surge in investment in Indian banks’ stocks, and therefore, understanding capital market risk is of critical interest to domestic and foreign investors in bank stocks, as well as to bank managers. Using panel data analysis of publicly listed private and public sector banks, our findings indicate that bank size, core capital-to-risk adjusted asset ratio, and interest spread of banks are significantly related to the total return risk of bank stocks. The market risk of bank stocks is significantly positively related to the amount of derivatives usage and to the return on asset ratio of banks. Also, the firm-specific risk component of bank stocks is significantly affected by the volume of total assets, interest spread, and their core capital-to-asset ratio. The interest rate risk exposure of bank stocks is significantly related to the core capital-to-asset ratio, and the interest spread. The off-balance sheet derivatives exposure, bank size, and the core capital to risk adjusted asset ratios are seen to have a significant effect on the overall systematic risk component of the bank stocks. The bank ownership structure, i.e., private versus public sector banks do not have any significant effect on the capital market risk measures.