Use of Derivatives for Interest Rate Risk Management
Interest Rate Floors
Banks can also lose earnings in periods of falling interest rates, especially when rates on floating rate loans decline. A bank can insist on establishing an interest rate floor under its loans so that no matter how far loan rates tumble, it is guaranteed some minimum rate of return.
Through this hedging device, the bank is guaranteed (assuming the borrower doesn't default) a minimum return on the loan. Banks use interest rate floors most of often when their liabilities have longer maturities than their assets or when they are funding floating rate assets with fixed rate debt.
Also read about :
Interest Rate Caps
Interest Rate Collars