WASHINGTONDerivatives
held by U. S. commercial banks increased $3.9 trillion in the fourth quarter,
to $71.1 trillion, the Office of the Comptroller of the Currency reported today
in its quarterly Bank Derivatives Report.
Following a lull
in the third quarter, bank derivatives activity returned to a more normal level
before the end of the year, said Kathryn E. Dick, the OCCs Deputy Comptroller
for Risk Evaluation. Ms. Dick noted
that most of the notional growth occurred in interest rate swaps, a favored tool
by risk managers seeking to adjust exposures to interest rate risk. The up tick in interest rates last year
appears to have sobered risk managers to the reality that interest rates dont
move in just one direction. Uncertainty
tends to create demand for risk management solutions. When used properly, derivatives are a
valuable risk management product to help bank institutional customers manage a
broad array of different risks arising from common business activities such as
securing long-term funding or protecting the value of importing or exporting
commercial goods.
Ms. Dick noted that
the notional amount of derivatives outstanding at the end of 2003 is a new
record. While notional amounts are a
reasonable reflection of business activity, they do not represent the amount at
risk for commercial banks. The risk in
a derivatives contract is a function of a number of variables, such as whether
counterparties exchange notional principal, the volatility of the currencies or
interest rates used as the basis for determining contract payments, the
maturity and liquidity of contracts, and the creditworthiness of the
counterparties in the transaction.
The OCC also
reported that earnings attributable to the trading of cash instruments and
derivatives activities decreased by $902 million in the three-month period, to
$2.1 billion. Commercial bank trading
revenues reflect profit and loss from both derivatives and cash trading
activities. There is a bit of a
seasonal pattern to revenues. The first
quarter is typically very strong and the fourth quarter tends not to be. In five of the past eight years, revenues in
the fourth quarter were the weakest of the year, and this was true again in
2003, said Ms. Dick.
She noted that
revenues remain depressed by ongoing tightening in credit spreads, which began
late in 2002. The good thing about
tightening credit spreads is that this trend suggests that market participants
are confident of continued improvement in asset quality, said Ms. Dick.
However, because
of accounting rules that treat hedges and the underlying loan assets
differently, tightening spreads cause banks to lose value in the contracts they
use to hedge credit risks in their loan portfolios, and this affected trading
revenues throughout the year.
The report also
noted that total credit exposure increased 5.2% in the fourth quarter to $755
billion. Total credit exposure has two
components: current credit exposure and potential future exposure. Current credit exposure, which represents the
mark-to-market gain on contracts with clients, net of losses on contracts to
those same clients where the bank has legally enforceable netting agreements,
increased 4.8% to $217 billion. The
current credit exposure is a measure of the amount banks have at risk today,
said Ms. Dick. However, its a measure
that overstates actual risk, because it doesnt include collateral held by
banks against those current exposures.
Potential future
exposure (PFE), the amount the current credit exposure might become over time,
increased 5.4% to $538 billion.
Notionals went up, and because the PFE is largely a function of
notional volumes, it too went up, said Ms. Dick. Like current credit exposure, the PFE measure also tends to
overstate credit risk. Banks report PFE
based upon the exposure that can occur over the full life of the contract,
using supervisory risk-based capital standards. However, for most large client relationships, banks have the
ability to close out the contracts if the client fails to post collateral when
required. A more accurate assessment of
the PFE for most large relationships, such as those between dealers, would be
the relatively short period of time, generally not more than a month, that
represents the time that passes between when a client fails to post collateral
until the bank can close out the relationship. Ms. Dick noted that OCC resident examiners at the largest
national banks include monitoring of counterparty exposure levels and risk
management practices in their on-ongoing supervision strategies.
During the fourth
quarter, the notional amount of interest rate contracts increased by $3.6
trillion, to $61.9 trillion. Foreign
exchange contracts increased by $271 billion to $7.2 trillion. This figure excludes spot foreign exchange
contracts, which decreased by $379 billion, to $273 billion. Equity, commodity and other contracts
decreased by $16.1 billion, to $1 trillion.
Credit derivatives increased by $132 billion, to $1 trillion.
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 10 percent. Equity, commodity and credit derivatives accounted for only three
percent of the total notional amount.
The number of
commercial banks actively engaging in derivatives remains small. The top seven commercial banks account for
almost 96 percent of the total notional amount of derivatives in the commercial
banking system, with more than 99 percent held by the top 25 banks. These large players have the most
sophisticated risk management systems, high caliber management, and are subject
to close supervision from bank regulators, said Ms. Dick.
The OCC third
quarter derivatives report also noted that:
·
Interest rate revenues decreased by $569 million in the
fourth quarter to $669 million.
Revenues from foreign exchange positions decreased by $252 million, to
$1.2 billion. Revenues from equity
trading positions decreased by $42 million, to $257 million in the fourth
quarter. Revenues from commodity and
other trading positions decreased by $38 million to $40 million.
·
The number of commercial banks holding derivatives
increased by 1, to 573.
A copy of OCC
Bank Derivatives Report: Fourth Quarter 2003 is available on the OCC Web
site: www.occ.treas.gov.
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The OCC charters, regulates and examines
approximately 2,100 national banks and 52 federal branches of foreign banks
in the U.S., accounting for more than 55 percent of the nations 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.
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