Publications:
Derivatives Fact Sheet -- Fourth Quarter 1995

Risk
Notional amounts are helpful in measuring the level and trends of derivatives activity. However, these amounts are 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 positions) while other data will be more useful over time in evaluating trends (e.g., revenue and maturity data).

In addition to the Call Report changes, the risk-based capital guidelines were amended as of the fourth quarter (1) to revise and expand the set of conversion factors used to calculate the potential future credit exposure of derivative contracts, and (2) to 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 new, higher conversion factors. New 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 the attached table reflect those new factors. However, the attached 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 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 this choice is left up to the bank, the attached table reflects only available Call Report information. Thus, the total credit exposures reported here represent upper bounds. If a bank has a legally valid bilateral netting arrangement, potential future credit exposure could be decreased.

The fourth quarter saw a $12 billion decrease in total credit exposure from off-balance sheet contracts to $228 billion. Relative to risk-based capital, total credit exposures for the top nine banks averaged 250.3 percent of capital compared to 272.9 percent at the end of the third quarter. This decrease in exposure is largely the result of declines in both U.S. interest rates and in various market volatilities, as well as the recognition of continuing benefits from bilateral netting. Credit exposure would have been significantly higher without the benefit of bilateral agreements. The extent of the benefit can be seen by comparing the positive replacement cost from Table 6 to the bilaterally-netted current exposures shown on Table 4. [See Table 4.]

Non-performing contracts remained at nominal levels. For all banks, the book value of contracts past due 30 days or more aggregated only $18 million or .0001 percent of total current exposure from all derivatives contracts. These figures reflect both the current healthy economic environment and the relatively high credit quality of counterparties and end-users with whom banks currently engage in derivatives transactions.

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 to risk management transactions. The banks with the 25 largest derivatives portfolios hold 94.1 percent of the contracts for trading purposes, primarily customer service transactions, while the remaining 5.9 percent are held for their own risk management needs. The trading contracts of these banks represent 91.4 percent of all notional values in the commercial banking system. Banks below the top 25, which use derivatives primarily for risk management transactions, hold 71.68 percent of their contracts for purposes other than trading. [See Table 5.]

The gross negative and gross positive fair values of derivatives portfolios show that banks are maintaining relatively balanced books; 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, the nine largest banks have $219.1 billion in positive fair values and $219.2 billion in negative fair values. These figures represent a slight decline from third quarter.

The decline in positive fair values corresponds to the reduction in credit risk mentioned above, while the decline in negative fair values means that banks owe their counterparties less. Note that while gross fair value data are very useful in depicting more meaningful market risk data, users must be cautioned that these figures do not include the results of cash positions in the trading portfolio. Similarly, the data are reported on a legal entity basis and consequently do not reflect effects of positions in portfolios of affiliates, and may result in double counting bank and non-bank affiliate positions.

End-user positions, or derivatives held for risk management purposes, have aggregate gross positive fair values of $14.4 billion, while the gross negative fair value of these contracts aggregated to $10.1 billion. Readers must be cautioned, however, that these results are only useful in the context of a more complete analysis of each bank's asset/liability structure and management process. [See Table 6.]

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