The decision of merger in Indian banking industry has resulted in the build-up of leverage. The risk exposure of banks is majorly elevated through the consolidated leverage, deposits, assets, massive NPAs, huge off-balance sheet risk exposure, forex reserves, etc.? Bank risk exposure is predicted by analysing the impact of risk factors such as interest rate risk, credit risk, market risk, exchange rate risk, etc. on the three major concepts namely the earnings, wealth and negative outcomes. The earnings and wealth represent the default probability / 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 trading on derivatives. In turn, derivatives have their own impact on the bank characteristics including its performance, risk exposure, efficiency and default probability / stability. The systematic literature review conducted primarily revealed the ‘moderating role of derivatives’ to be the major gap yet to be studied on this area. Hence, 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/default probability, efficiency and market value)’ has been performed to help banks and regulators gain the following benefits:
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, potential to enhance stability and value impact.
3. The results and the model proposed might form part of an extended contribution in the existing literature