Why Do Banks Use Derivatives? An Analysis of the Italian Banking System

The derivatives market has experienced quick growth all over the world in the last two decades. Banks decide to participate in the derivatives market either to hedge against unexpected movements in economic variables or for trading and broker-dealer activities. This paper analyses, by means of multivariate descriptive statistical tools, the determinants of Italian banks’ use of derivatives over a long time horizon (2003-2017) by using quarterly Bank of Italy supervisory data. We find that size and being part of a banking group positively affect banks’ use of derivatives. Moreover, banks mainly employ derivatives for hedging purposes, especially to hedge against interest rate and credit risks. Finally, derivatives represent a hedging alternative to capital and liquidity. Our results are robust to different specifications that take into account the classification of derivatives by purpose (hedging versus trading) and the distinction between dealer versus end-user banks.