March 31, 2006
OCC Reports Derivatives Volume Tops $100 Trillion
WASHINGTON – The notional amount of derivatives held by U.S. commercial banks increased by $2.7 trillion in the fourth quarter of 2005, to a record $101.5 trillion, the Office of the Comptroller of the Currency reported today in its quarterly Bank Derivatives Report.
“The notional amount of a derivatives contract is generally only used to determine cash flows on the contract and is not a measure of the amount of risk,” said Deputy Comptroller for Credit and Market Risk, Kathryn E. Dick.
Ms. Dick noted that net current credit exposure is the metric most representative of credit risk in derivatives portfolios, and this figure is derived by applying the benefit banks achieve from having legally enforceable netting contracts to the gross positive fair value. As of year-end, the gross positive fair value was $1.22 trillion and the netting benefit was 84.4%, resulting in a net current credit exposure of $190 billion, which is down 10% from the end of the third quarter, she said.
“The large dealer banks have many contracts with each other and legally enforceable netting agreements are a useful risk mitigation technique, allowing a dealer to use the negative value it owes a counterparty to offset the positive value owed to it by that same counterparty,” Ms. Dick said.
The OCC also reported that revenues attributed to trading of cash instruments and derivative activities in the three-month period totaled $3.13 billion.
“When you hit a record in revenues, as in the third quarter, the path of least resistance is down,” Ms. Dick said. “Overall, 2005 was a good year for bank trading results, but it was a bit of a bumpy ride. The top 5 banks earned a record $11.9 billion in 2005, compared to $7.3 billion in 2004, and an average of $8.9 billion over the past four years.”
Ms. Dick pointed to the continued strong growth in credit derivatives, which increased 14% to $5.8 trillion in the fourth quarter, as an area receiving close attention from OCC examiners on-site at the large dealer banks.
“Credit derivatives can be a very effective credit risk hedging tool, but they can also be used to create some very complicated investment structures,” Ms. Dick said. “Some of the products lack price transparency, so they present a real challenge from a valuation standpoint.”
Ms. Dick underscored that two key aspects of the OCC’s supervision program for credit derivatives activities in the large dealer banks are the evaluation of risk management systems used to ensure that products they sell to clients are appropriately marketed and that middle and back-office functions are keeping pace with innovations in product structures.
The OCC fourth quarter derivatives report also noted that:
- Foreign exchange revenues increased by $311 million, to $1.76 billion; equity revenues decreased by $400 million, to $845 million; interest rate revenues decreased by $837 million, to $813 million; and commodity/other revenues decreased by $799 million, to a loss of $292 million.
- Potential future exposure (PFE) increased 8 percent to $915 billion. Total credit exposure, the sum of net current credit exposure and potential future exposure, increased 4 percent to $1.11 trillion.
- The 25 largest banks account for more than 99 percent of the total notional amount of derivatives. The largest 5 banks account for 96% of the total notional amount of derivatives.
- The notional amount of short-term contracts (those with maturities of less than one year) increased by 9 percent, medium-term contracts (maturities of one to five years) increased by 1 percent and long-term contracts (over five years) increased by 5 percent.
- The number of commercial banks holding derivatives increased by 31 to 836 banks.
A copy of the OCC Bank Derivatives Report: Fourth Quarter 2005 is available on the OCC Web site: www.occ.gov .