Publications:
Quarterly Derivatives Fact Sheet -- Fourth Quarter 1996

Risk
Notional amounts are helpful in measuring the level and trends of derivatives activity. However, these amounts may be a misleading indicator of risk exposure. Beginning in the first quarter of 1995, the Call Report provided data that improve disclosure and understanding of the relative riskiness of bank activities involving derivatives. Some of the data provide immediate information (e.g., fair values and credit risk exposures) while other data will be more useful over time in evaluating trends (e.g., trading revenue and contractual maturity data).

In addition to the Call Report changes, the risk-based capital guidelines were amended as of the second quarter of 1995 to (1) revise and expand the set of conversion factors used to calculate the potential future credit exposure of derivative contracts, and (2) recognize the effect that qualifying bilateral netting arrangements will have on the potential future credit exposure for derivative contracts. Contracts with the longest maturities (i.e., over five years) are now subject to higher conversion factors. Different conversion factors were also established that specifically apply to derivative contracts related to equities, precious metals, and other commodity contracts. The credit exposure calculations in Table 4, reflect those new factors. However, that table does not reflect the effects of bilateral netting on potential future credit exposures.

Under the new risk-based capital guidelines, banks have the option of either calculating their netted potential future credit exposure on a counterparty basis or approximating their netted potential future credit exposure on an aggregate basis (so long as the method chosen is used consistently and is subject to examiner review). Since available Call Report information does not reflect the impact of netting on future credit exposure, the total credit exposures reported here are most likely overstated. If a bank has a legally valid bilateral netting arrangement, potential future credit exposure could be decreased.

The fourth quarter realized a $13 billion increase in total credit exposure from off-balance sheet contracts, to $252 billion. Relative to risk-based capital, total credit exposures for the top eight banks remained at 236.9 percent of aggregated capital in the fourth quarter. The increase in the dollar amount of total credit exposure appears to be largely a result of changes in market rates over the fourth quarter. Credit exposure would have been significantly higher without the benefit of bilateral netting agreements. The extent of the benefit can be seen by comparing gross positive fair values from Table 6 to the bilaterally-netted current exposures shown on Table 4. [See tables 4 and 6.]

Non-performing contracts remained at nominal levels. For all banks, the book value of contracts past due 30 days or more aggregated only $3 million, or 0.001 percent of total credit exposure from derivatives contracts. As of the fourth quarter 1996, banks with derivative contracts reported $37 million in credit losses from off-balance sheet derivatives. This number represents the year-to-date charge-offs incurred from off-balance sheet contracts. These figures reflect both the current healthy economic environment and the relatively high credit quality of counterparties and end-users with whom banks presently engage in derivatives transactions, as well as the increased use of collateral.

The Call Report data reflect the significant differences in customer bases and business strategies among the banks. The preponderance of trading activities, including both customer transactions and proprietary positions, is confined to the very largest banks. Smaller banks tend to limit their use of derivatives for risk management purposes. The banks with the 25 largest derivatives portfolios hold 93.7 percent of the contracts for trading purposes, primarily customer service transactions, while the remaining 6.3 percent are held for their own risk management needs. The trading contracts of these banks represent 91.8 percent of all notional values in the commercial banking system. Banks below the top 25, which use derivatives primarily for risk management transactions, hold 72.3 percent of their contracts for purposes other than trading. [See Table 5 .]

The gross negative and gross positive fair values of derivatives portfolios are relatively balanced; that is, the value of positions in which the bank has a gain is not significantly different from the value of those positions with a loss. In fact, for derivative contracts held for trading purposes, the eight largest banks have $244 billion in gross positive fair values and $245 billion in gross negative fair values. Note that while gross fair value data are very useful in depicting more meaningful market risk exposure, users must be cautioned that these figures do not include the results of cash positions in trading portfolios. Similarly, the data are reported on a legal entity basis and consequently do not reflect the effects of positions in portfolios of affiliates.

End-user positions, or derivatives held for risk management purposes, have aggregate gross positive fair values of $10.6 billion, while the gross negative fair value of these contracts aggregated to $9.1 billion. Readers must be cautioned, however, that these figures are only useful in the context of a more complete analysis of each bank's asset/liability structure and management process. For example, these figures do not reflect the impact of off-setting positions on the balance sheet. [See Table 6.]

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