DERIVATIVES USE AND BANK PERFORMANCE: EVIDENCE FROM SELECTED MENA COUNTRIES

Abstract

Financial derivatives constitute a fundamental component of contemporary banking risk management serving as instrument for hedging interest are and foreign exchange rate risks, Nonetheless, they also introduce additional risks when employed for speculative purposes or inadequately managed. Despite their significance, empirical evidence regarding the overall impact of derivatives on banking performance remains inconclusive. This study aims to address this critical gap by investigating the use of derivatives and their effects on banking performance within the Middle East and North Africa (MENA) region. Specifically, the research examines the influence of derivative usage on the net interest margin (NIM), which serves as a proxy for both profitability and the efficiency of financial intermediation, and compares these effects between Islamic and conventional banks operating in the region. This study utilizes quantitative analysis through panel data modeling, employing on the frequency of banks' disclosure of derivatives as a proxy for of the use of derivatives. The primary findings reveal a negative and statistically significant correlation between the use of financial derivatives and the net interest margin (NIM). This relationship suggests enhanced financial system efficiency, as a lower NIM may serve as an indicator of improved efficiency, leading to greater stability in cash flows and a reduction in future risks for banks. This result indicates that hedging contributes to maximizing stability and minimizing risk, although it does not translate into immediate profit (NIM). The components of derivative use elucidate the mechanisms through which the negative relationship is established. Specifically, derivatives employed to hedge interest rate risk and foreign exchange risk account responsible for this relationship whereas commodity risk derivatives are insignificant, as expected for banks.

The comparative analysis indicates that there is no significant difference between Islamic and conventional banks concerning the effect of derivative usage on net margin. This study offers empirical evidence specific to the MENA region, thereby equipping policymakers and legislators with essential information to formulate effective regulatory policies for the financial sector.