During the rollicking third quarter of 1998, says the Office of the Comptroller of the Currency in its “Third Quarter 1998 Banks Derivatives Report,” banks charged off $445 million as a result of credit losses from off-balance sheet derivatives, up from $94 million in the second quarter. Credit losses for the quarter climbed from .03 percent to 0.11 percent of total credit exposure—a sizable jump, but still less than half the loss ratio for commercial and industrial loans during the same period. The losses, says Michael Brosnan, deputy comptroller for risk evaluation at the OCC, reflected the unsettled economic environments in Asia and Eastern Europe.

As a result of the tumultuous markets, moreover, U.S. commercial banks increased the notional amount of derivatives in their portfolios by $4.5 trillion, or 16 percent, to a record $32.6 trillion in the third quarter. Most of the increased activity was in interest rate contracts, which rose by $3.8 trillion to $23.8 trillion during the period. “The significant increase,” says Brosnan, “was primarily due to banks providing products to corporate customers to help them meet risk management requirements during the third quarter.”

Past-due derivatives contracts remained at nominal levels. For all banks, the book value of contracts 30 days or more past due totaled only $28.9 million, or .007 percent of total credit exposure from derivatives contracts. That figure, however, doesn’t include derivative contracts accounted for on a non-performing basis.

During the third quarter, says the report, revenues from trading activity at commercial banks fell to $614 million, a steep drop from the $2.6 billion recorded during the second quarter. While revenue from foreign exchange positions was $1.2 billion, losses were reported for interest rate positions (-$284 million), commodity and other positions (-$222 million), and equity positions (-$65 million). For the seven banks that account for nearly 94 percent of the industry’s derivatives activity, revenue from this activity fell to only 0.8 percent of gross revenue. It stood at 6.9 percent the second quarter and generally has been more than 5 percent for each quarter since 1995.

Credit derivatives continued to grow, reaching $162 billion in notional volume during the third quarter. According to the report, the product has more than quadrupled in size since the third quarter of 1997. “Risk managers are increasing their use of this product to control their credit risk by diversifying and/or hedging their portfolios,” said Brosnan. He said that he envisions continued growth of this product.

Figure 1

It is important to note that the OCC’s figures include only U.S. commercial banks—not foreign banks or securities firms such as Credit Suisse First Boston, Lehman Brothers and Merrill Lynch, all major players in the derivatives marketplace.

For a copy of the report, see http://www.occ.ustreas.gov/ftp/deriv/dq398.pdf.

Figure 2 Derivatives Holdings Among Commercial Banks as of September 30, 1998*
Rank	Bank Name	State	Total Assets	Total Derivatives
1	CHASE MANHATTAN BANK	NY	$292,620	$9,450,579
2	MORGAN GUARANTY TR CO OF NY	NY	$198,154	$8,491,525
3	CITIBANK NA	NY	$296,122	$3,805,044
4	NATIONSBANK NATIONAL ASSN	NC	$258,714	$3,140,618
5	BANKERS TRUST CO	NY	$121,364	$2,483,707
6	BANK OF AMERICA NT&SA	CA	$244,277	$1,957,041
7	FIRST NB OF CHICAGO	IL	$61,971	$1,353,659
8	BANK OF NEW YORK	NY	$60,466	$301,172
9	REPUBLIC NB OF NEW YORK	NY	$45,907	$235,467
10	FIRST UNION NATIONAL BANK	NC	$218,079	$230,986
11	STATE STREET BANK & TRUST CO	MA	$46,262	$139,036
12	BANKBOSTON NATIONAL ASSN	MA	$70,377	$142,341
13	FLEET NATIONAL BANK	RI	$71,367	$91,997
14	MELLON BANK NATIONAL ASSN	PA	$40,106	$72,965
15	WELLS FARGO BANK NA	CA	$85,444	$70,371
16	KEYBANK NATIONAL ASSN	OH	$73,486	$57,842
17	PNC BANK NATIONAL ASSN	PA	$70,656	$48,368
18	BANK ONE NATIONAL ASSN	OH	$23,579	$38,385
19	NATIONAL CITY BANK	OH	$28,043	$37,857
20	CHASE MANHATTAN BANK USA NA	DE	$31,025	$29,871
21	FIRST TENNESSEE BANK NA	TN	$16,261	$24,888
22	WACHOVIA BANK NATIONAL ASSN	NC	$62,200	$27,302
23	CHASE BANK OF TEXAS NA	TX	$23,614	$21,187
24	SUNTRUST BANK ATLANTA	GA	$18,071	$19,354
25	CITIBANK SOUTH DAKOTA NA	SD	$13,245	$18,570
Top 25 commercial banks & TCs with derivatives			$2,471,412	$32,290,132
Other 439 commercial banks & TCs with derivatives			$1,603,066	$350,584
Total amounts for all 464 banks and TCs with derivatives			$4,074,478	$32,640,716
*figures are preliminary Source: Office of the Comptroller of the Currency

BIS Estimate: $70 Trillion and Counting

Last December, the Bank for International Settlements issued what it called the first installment of semi-annual statistics on the size and structure of the global over-the-counter derivatives market. The statistics include the notional amounts and gross market values outstanding of the worldwide consolidated OTC derivatives exposure of major banks and dealers in the G-10 countries. They cover the four main categories of market risk: foreign exchange, interest rate, equity and commodity.

After adjustment for double-counting resulting from positions between reporting institutions, the total estimated notional amount of outstanding OTC contracts stood at $70 trillion at the end of June 1998. While this figure was 47 percent higher than the estimate for the end of March 1995, after adjusting for differences in exchange rates and the change from locational to consolidated reporting, the increase balloons to 130 percent.

The 1998 data, says the report, “confirm the predominance of the OTC market over organized exchanges in financial derivatives business.” Interest rate instruments are the largest OTC component—67 percent, mainly in swaps—followed by foreign exchange products (30 percent, mostly outright forwards and foreign exchange swaps) and those based on equities and commodities (2 percent and 1 percent, respectively). Currency contracts are much shorter in duration than interest rate contracts, the report notes, since 87 percent of currency contracts expire within 12 months, compared with 41 percent for interest rate contracts. Also, while the U.S. dollar is counterpart in 86 percent of foreign exchange contracts, only 31 percent of interest-rate-related positions are denominated in dollars. “This confirms other evidence of the expansion of the swap market outside the U.S. dollar sector, in particular in European currencies,” says the report.

At the end of June 1998, says the BIS report, estimated gross market values stood at $2.4 trillion, or 3.5 percent of the reported notional amounts. But the report notes that “such values exaggerate actual credit exposure, since they exclude netting and other risk-reducing arrangements. Allowing for netting lowers the derivatives-related credit exposure of reporting institutions to $1.2 trillion, or to 11 percent of on-balance-sheet international banking assets.” The ratio of gross market values to notional amounts varied considerably across individual market segments—from less than 1 percent for forward rate agreements to more than 15 percent for equity-linked options.

Figure 1 The Global OTC Derivatives Markets: Positions at end-June 1998, in billions of U.S. dollars
	1998		1995
	Notional amounts	Gross market Values	Notional amounts	Gross market Values
A. Foreign exchange contracts	18,719	799	13,095	1,048
Outright forwards and forex swaps	12,149	476	8,699	622
Currency swaps	1,947	208	1,957	346
Options	4,623	115	2,379	71
B. Interest rate contracts	42,368	1,160	26,645	647
FRAs	5,147	33	4,597	18
Swaps	29,363	1,018	18,283	562
Options	7,858	108	3,548	60
C. Equity-linked contracts	1,274	190	579	50
Forwards and swaps	154	20	52	7
Options	1,120	170	527	43
D. Commodity contracts	451	38	318	28
Gold	192	10	147	10
Other	259	28	171	18
Forwards and swaps	153	..	120	13
Options	106	..	51	5
E. Estimated gaps in reporting	7,100	240	6,893	432
GRAND TOTAL	69,912	2,427	47,530	2,205
GROSS CREDIT EXPOSURE	n/a	1,203	n/a	n/a
Source: Bank for International Settlements

Thrifts Join Risk Management Party

The risk management revolution has hit small-town thrift institutions. Last December 1, the Office of Thrift Supervision adopted new, comprehensive guidelines to help savings associations manage their risks. Thrift Bulletin 13a combines all the guidelines, which cover interest rate risk, investment securities and the use of financial derivatives.

The OTS didn’t stop there: it also replaced with a single rule three rules on forward commitments, futures transactions and financial options that had been in place since 1982. The new rule, which went into effect on January 1, establishes basic requirements applicable to all derivatives and is designed to accompany the bulletin.

Before publishing Bulletin 13a, the OTS put the proposal and the new rule out for public comment. Based on the comments received, two major changes were made: a less-stringent set of quantitative guidelines were adopted as a starting point for examiners to use in their determination of an institution’s sensitivity to the market risk component of the CAMELS rating system; and the threshold was reduced for allowing institutions to use financial derivatives or other complex investment securities in ways that might not reduce the overall level of interest rate risk in their total portfolios.

The OTS also announced that it will examine whether to eliminate the interest rate risk component of its capital regulation in light of the tools that are currently available to measure and control interest rate risk.

For more information on the bulletin and the new derivatives rule, see www.ots.treas.gov.

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