WASHINGTON—Derivatives
held by U. S. commercial banks increased $3.2 trillion in the third quarter, to
$84 trillion, the Office of the Comptroller of the Currency reported today in
its quarterly Bank Derivatives Report.
Kathryn Dick, the OCC’s
Deputy Comptroller for Risk Evaluation, noted that the notional amount of
derivatives outstanding is a new record.
Ms. Dick noted that while “notional volumes are a useful indicator of
business activity, they don’t tell us much about risk, since notional amounts
are seldom exchanged in bank derivative contracts.” The risk in a derivatives contract is a function of a number of
variables, such as whether counterparties exchange notional principal, and the
volatility of the market factor used to determine contract payments. The risk in a derivative contract also is a
function of the maturity and liquidity of contracts, and the creditworthiness
of the counterparties in the transaction.
The report also noted that total credit exposure, the sum of netted
current exposure plus potential future exposure, increased $52 billion in the
third quarter to $804 billion. “While
the Federal Reserve continued to raise overnight rates in the third quarter,
yields on longer term instruments actually declined modestly during the
quarter, and that had the effect of increasing current credit exposures,” said
Ms. Dick. The mark-to-market gain on
derivatives receivables (gross positive fair values), increased $147 billion,
or 14.8%, to $1.15 trillion. Banks were
able to net $965 billion of the derivatives payables against their derivatives
receivables in the third quarter, up from $829 billion in the second
quarter. Therefore, netted current
credit exposure, which is derivatives receivables minus netting benefits,
increased $11 billion to $183 billion.
Potential future
exposure (PFE), which is an estimate of how high credit exposure on existing
contracts can become over time, increased $41 billion, largely due to increases
in the notional amounts of derivatives contracts over 1 year, as well as
foreign exchange and commodity contracts with maturities from 1-5 years. The $41 billion increase in PFE plus the $11
billion increase in netted current credit exposure yields the $52 billion
increase in total credit exposure.
“By any measure, the
credit numbers are large and we monitor these exposures closely,” said Ms.
Dick. “However, they are based upon the
risk-based capital rules used by the banking agencies, and they do tend to
overstate the actual amount of credit risk.”
Ms Dick explained that both the current credit and potential future
exposure numbers do not take into consideration mitigating factors. “Generally, the big dealers tend to have
30-40% of their netted current exposures secured by collateral, largely
cash. So, a more accurate assessment of
current credit exposures would subtract liquid collateral values.” Ms. Dick noted that the PFE numbers are also
overstated because they require capital for transactions that might offset each
other. In such a case, a default by
both counterparties simultaneously can only involve a loss on one of the
contracts. Moreover, the PFE data do
not consider whether a contract has a large negative value to the bank, in
which case the contract may never have positive value. The risk-based capital rules currently
require capital as if the transaction had a zero value. “The banking agencies are aware of the
deficiencies in the current risk-based capital structure for derivatives. We are participating in an effort to explore
possible changes, as part of the process of implementing the new Basel capital
framework,” said Ms. Dick.
Credit risk performance
indicators confirmed the positive view of credit quality as reflected by narrow
corporate credit spreads. The report
noted that only a small fraction of derivatives contracts were 30 days or more
past due. For all banks, the fair value
of contracts past due 30 days or more totaled only $41 million, or .005 percent
of total credit exposure from derivative contracts. Derivatives charge-offs for the quarter were $91 million, and
represent .01134 percent of total derivative exposures, well below the .073
percent for C&I loans.
During the third
quarter, the notional amount of interest rate contracts increased by $2.4
trillion, to $73 trillion. The amount
of foreign exchange contracts increased by $163 billion, to $7.9 trillion. This figure excludes spot foreign exchange
contracts, which decreased by $27 billion, to $645 billion. Equity, commodity and other contracts
increased by $165 billion, to $1.3 trillion.
Credit derivatives increased by $423 billion, to $1.9 trillion. Ms. Dick noted that growth in credit
derivatives was strong for all of the major dealers. “We see continued growth in this market, due to portfolio hedging
and client demand for collateralized debt obligations,” said Ms. Dick.
The OCC indicated that
revenues reported by banks trading cash and derivatives instruments decreased
by $1.3 billion in the third quarter, to $1.3 billion. “Similar to what we saw in the second
quarter, the third quarter was not a good one for trading revenues,” said Ms.
Dick. “Our examiners report that
trading results were adversely affected by a combination of weak client demand
and unfavorable market moves relative to the directional bias in their trading
books.” Additionally, Ms. Dick noted
that the trading results continue to be adversely influenced by non-trading
activity, such as credit derivative hedges of loan portfolio exposures.
The derivatives
business remains largely concentrated in interest rate contracts. Overall, 87 percent of the notional amount
of derivatives positions was comprised of interest rate contracts, with foreign
exchange accounting for an additional 9 percent. Equity, commodity and credit derivatives accounted for the remaining
four percent of the total notional amount.
The OCC third quarter
derivatives report noted that the number of commercial banks holding
derivatives increased by 30, to 667.
A copy of OCC Bank
Derivatives Report: Third Quarter 2004 is available on the OCC Web site: www.occ.treas.gov.
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The OCC charters, regulates and examines approximately 2,000 national
banks and 51 federal branches of foreign banks in the U.S., accounting for more
than 56 percent of the nation’s banking assets. Its mission is to ensure a safe
and sound and competitive national banking system that supports the citizens,
communities and economy of the United States.