Bank Lending in Dual Narratives: Economic Policy Uncertainty and Interest-Rate Derivatives

Abstract

This research aims to examine whether banks can employ interest-rate derivatives to mitigate or intensify the effects of economic policy uncertainty on bank lending. By testing two opposing hypotheses, it offers valuable insights into how the interplay between bank lending, interest-rate derivatives, and EPU can influence bank’s loan growth. Using a sample of 1,285 Bank Holding Companies (BHCs) for the period from 1986 to 2017, panel regression analysis confirms a negative relationship between EPU and Commercial Industrial (C&I) loan growth. This negative association is not only statistically significant but also economically meaningful. Specifically, when EPU increases by one standard deviation, bank holding companies (BHCs) experience a decrease in loan growth rate by 91 basis points. While derivative users exhibit a significantly higher mean loan growth compared to non-users, the interaction term between interest-rate derivative usage and EPU is negative and statistically significant. This suggests that the usage of interest-rate derivatives aggravates the negative impact of EPU on bank lending.