Disclosure of Off-Balance-Sheet Derivatives

FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL

Disclosure of Off-Balance-Sheet Derivatives

AGENCY: Federal Financial Institutions Examination Council.

ACTION: Request for comment.

-----------------------------------------------------------------------

SUMMARY: The Federal Financial Institutions Examination Council (FFIEC)

is proposing to revise the information reported on certain off-balance-

sheet activities in the Consolidated Reports of Conditions and Income

(Call Report). Schedule RC-L, ``Off-Balance-Sheet Items,'' would be

expanded to distinguish between the notional (or par) value data for

futures, forwards, written options, purchased options, and swaps, for

commodity and equity products, as well as interest rate and foreign

exchange contracts as currently required. Written and purchased options

would be separated into exchange-traded and over-the-counter contracts.

All banks would be required to report these data.

In Schedule RC-L banks, with greater than $100 million in assets

would also be required to report gross positive and negative fair

values for interest rate, foreign exchange, commodity, and equity

derivative contracts. These fair value data would be reported

separately for derivative contracts accounted for a on a mark-to-market

or lower-of-cost-or-market (LOCOM) basis and for derivative contracts

accounted for on an accrual or hedge accounting basis. In addition,

banks with greater than $100 million in assets would be required to

report a single net current credit exposure (with respect to legally

enforceable bilateral netting agreements) across all derivative

contracts and counterparties.

Also, for banks with greater than $100 million in assets, Schedule

RI, ``Income Statement,'' would be changed for the addition of three

memoranda line items. In one memoranda item, banks would be required to

report income related to off-balance-sheet instruments accounted for on

a mark-to-market or LOCOM basis. In the remaining memoranda line items,

banks would be required to report the impact on their net interest

income of off-balance-sheet instruments accounted for on an accrual or

hedge accounting basis.

Changes to Schedule RC-L would be implemented for the September 30,

1994 Call Report. Changes to Schedule RI would be implemented for the

March 31, 1995 Call Report.

DATES: Comments must be received by May 9, 1994.

ADDRESSES: Comments should be directed to Joe M. Cleaver, Executive

Secretary, Federal Financial Institutions Examination Council, 2100

Pennsylvania Avenue, NW., suite 200, Washington, DC 20037. (Fax number

(202) 634-6556.)

FOR FURTHER INFORMATION CONTACT:

Curtis Wong, Capital Markets Specialist, Federal Deposit Insurance

Corporation (202) 898-7327; Robert F. Storch, Chief, Accounting

Section, Division of Supervision, Federal Deposit Insurance Corporation

(202) 898-8906; Gerald A. Edwards, Jr., Assistant Director-Division of

Banking Supervision and Regulation, Federal Reserve Board (202) 452-

2741; Charles Holm, Project Manager, Federal Reserve Board (202) 452-

3502; Mark Winer, Director of Regulatory and Statistical Analysis,

Office of the Comptroller of the Currency (202) 874-5240; Karen Epps,

Professional Accounting Fellow, Office of the Comptroller of the

Currency (202) 874-5180.

SUPPLEMENTARY INFORMATION:

Background

The size and scope of banks' activities in off-balance-sheet

derivatives has grown substantially over the last several years. Off-

balance-sheet derivatives can give rise to risks and rewards that may

not be reflected in amounts recognized on a bank's balance sheet.

Generally, under the current Call Report requirements, explicit

disclosures about off-balance-sheet derivative financial instruments by

all banks are limited to the notional (or par) values of all contracts

and positive replacement costs of contracts subject to risk-based

capital requirements. Larger banks will shortly provide certain limited

additional disclosures related to off-balance-sheet derivatives. The

banking agencies believe that current Call Report requirements for off-

balance-sheet contracts need to be improved to provide better

information on the nature and extent of these activities and the risk

exposures of individual banks and the banking system.

In developing these proposed changes to the Call Report, the

banking agencies have been mindful of other major reporting changes

anticipated in the near future. For example, when the revisions to

risk-based capital standards for the measurement of interest rate risk

mandated by section 305 of the Federal Deposit Insurance Corporation

Improvement Act of 1991 (FDICIA) are implemented, significant changes

may be required to the Call Report. These changes will primarily focus

on the exposure for changes in a bank's economic value caused by

changes in interest rates. In addition, the Basle Supervisors'

Committee has undertaken a project which may result in an explicit

capital charge for market risk in bank trading activities and expanded

reporting of derivative maturities.

Based upon these possible future changes, the banking agencies have

focused the disclosures recommended below on items that are not

addressed by the current proposals on interest rate and market risk.

Hence, the banking agencies believe that any future changes to off-

balance-sheet derivative reporting caused by these proposals will

supplement rather than replace the information specified below.

In addition, the banking agencies have noted that much of the

information requested in these proposed Call Report changes is

available through bank examinations. However, the collection of

recommended disclosures in the Call Report would enhance the agencies'

ability to monitor financial derivatives activities between

examinations. Disclosure through the Call Report would also enhance the

agencies' ability to analyze data that would be provided across the

industry, at consistent points in time and in a consistent manner.

Description of Proposed Call Report Changes to Schedule RC-L

Schedule RC-L of the Call Report, ``Off-Balance-Sheet Items,''

contains information about bank financial commitments which, for

accounting purposes, may not be reported on the balance sheet. Data

currently reported in items 1-10, items 14 and 15 and in the Memoranda

section of Schedule RC-L would remain the same under this proposal. The

format and nature of data reported in items 11-13 would be changed

beginning with the Call Reports filed for September 30, 1994.

Separate line items would be provided for the reporting of gross

notional (or par) values of outstanding futures, forwards, swaps,

exchange-traded written options, exchange-traded purchased options,

over-the-counter written options, and over-the-counter purchased

options. These data would be reported for interest rate, foreign

exchange, commodity and equity contracts. Although the format of

notional (or par) value reporting on Schedule RC-L has been revised,

disclosure on a gross basis is unchanged from current reporting in

items 11-13 and all banks would continue to report notional (or par)

value data.

Spot foreign exchange contracts, which are now reported as a

component of item 11b, ``Commitments to purchase foreign currencies and

U.S. dollar exchange,'' would be reported in a new Schedule RC-L item

separate from off-balance-sheet derivative contracts.

Banks with foreign offices or with total assets of $100 million or

more that file the FFIEC 031, 032 and 033 report forms would be

required to report additional information about these off-balance-sheet

derivative contracts. Banks would report the gross positive fair values

and gross negative fair values of interest rate, foreign exchange,

commodity and equity contracts for (i) contracts accounted for at

market value or LOCOM, and (ii) contracts accounted for on a hedge or

accrual basis. Reporting on a ``gross basis'' means that no netting of

contracts would be permitted.

Banks that file the FFIEC 031, 032 and 033 report forms would also

be required to report a single net current credit exposure, with

respect to legally enforceable bilateral netting agreements across all

derivative contracts and counterparties. The amount would be derived

through an analysis performed on an individual counterparty basis.

First, the bank would determine whether a legally enforceable bilateral

netting agreement is in place. If such an agreement is in place, the

fair value of all applicable contracts with that counterparty would be

netted to a single amount. If such an agreement is not in place, the

total of all contracts with that counterparty that have positive fair

values would be determined. The bank would then report the sum of (i)

net positive fair values associated with counterparties for which

legally enforceable bilateral netting agreements are in place and (ii)

the positive fair values of all contracts for which a legally

enforceable bilateral netting agreement is not in place.

Consistent with current risk-based capital guidelines, the amount

of the bank's single net current credit exposure would exclude foreign

exchange contracts with an original maturity of 14 calendar days or

less, interest rate or foreign exchange contracts that are traded on an

exchange requiring the daily cash settlement of any variations in the

market value of the contracts, and written option contracts.

Description of Proposed Call Report Changes to Schedule RI

Banks that file the FFIEC 031, 032 and 033 report forms currently

report income (including market value gains) from off-balance-sheet

derivatives which are held for dealing or trading purposes or which are

otherwise accounted for at market or LOCOM in the noninterest income

category of Schedule RI, ``Income Statement.'' Such amounts are

primarily reported in items 5c and 5f(2), ``Trading gains (losses) and

fees from foreign exchange transactions'' and ``All other noninterest

income,'' respectively.

It is proposed that a new Schedule RI Memoranda item be created and

captioned, ``Income from off-balance-sheet derivative instruments

accounted for at market value of LOCOM.'' In this memoranda item, banks

would report the sum of all amounts reported in Schedule RI noninterest

income and noninterest expense items which were recognized from off-

balance-sheet derivative transactions, including market value gains and

losses.

In addition, for banks that file the FFIEC 031, 032 and 033 report

forms, a change is proposed to capture data regarding the amount of

off-balance-sheet derivative income and expense included in net

interest income. Under current practice, many banks report periodic net

settlements for many swaps and other amounts related to off-balance-

sheet instruments accounted for on the hedge or accrual basis as

components of the interest income or interest expense Call Report line

items to which they relate. For example, if a swap is intended to hedge

interest rate risk on commercial loans, the bank may report the income

or expense associated with new settlement accruals on that swap in the

income statement item for ``Interest and fee income on commercial

loans'' in Schedule RI of the Class Report. The FFIEC is not proposing

to change this existing reporting practice.

It is proposed that a Schedule RI Memoranda item be created and

captioned, ``Impact on net interest income of off-balance-sheet

activities.'' Data on this impact would then be collected in two

subitems: one called, ``Net increase (decrease) to interest income,''

and another called, ``Net (increase) decrease to interest expense.'' In

the first memoranda item, banks would report the net sum of all amounts

reported in Schedule RI interest income items which were recognized

from off-balance-sheet derivative transactions. In the second memoranda

item, banks would report the net sum of all amounts reported in

Schedule RI interest expense items which were recognized from off-

balance-sheet derivative transactions.

All of these changes to Schedule RI would first be effective in

Call Reports filed for March 31, 1995.

Accounting for Off-Balance-Sheet Derivative Financial Instruments

Several of the reporting changes proposed to Schedules RC-L and RI

distinguish between off-balance-sheet derivative financial instruments

that are accounted for on a market value or LOCOM basis and those

accounted for on a hedge or accrual basis. This proposal would not

change the accounting methods prescribed in the Call Report

instructions for futures, forwards and standby contracts. The proposed

reporting changes collect supplemental information on such contracts in

accordance with the accounting methodology that is applied by the bank

of Call Report purposes.

Purpose of Additional Data Requested

Notional and Par Value Data

Notional (or par) value data as currently reported in Schedule RC-L

provide valuable information regarding the scope and volume of

individual bank and banking system off-balance-sheet derivative

activities. However, notional (or par) value data provide little

information about the risks to which individual banks and the banking

system may be exposed.

The separate reporting proposed for futures, forwards and options

distinguishes between exchange-traded and over-the-counter (OTC)

derivative transactions. Information about the volume of off-balance-

sheet derivative transactions that are exchange-traded versus OTC will

provide additional insight as to credit, liquidity and systemic risk

exposures.

Current and potential credit exposure can be of greater concern for

OTC derivative contracts, because futures and options exchanges

generally limit the performance period of their contracts to one day

through daily mark-to-market and cash settlement of positions as well

as margin provisions. In addition, the exchanges (through their

clearing members) hold collateral in an amount approximately equal to

the potential one-day change in the value of the contract at the

beginning of each trading day. Therefore, exchange-traded contracts

generally contain relatively little credit exposure.

However, there is not a perfect distinction between counterparty

credit exposure on exchange-traded and OTC contracts. Contracts traded

on foreign exchanges may be subject to less restrictive margin or

collateral requirements than those traded on U.S. exchanges. Further,

in today's marketplace, many OTC contracts have collateral and margin

requirements. Although these distinctions have limitations, the banking

agencies believe these data may provide some additional information on

counterparty credit risk. In conjunction with the additional fair value

and net counterparty credit exposure data discussed below, this

information will enhance supervisory understanding of off-balance-sheet

derivative credit risk in individual banks and across the banking

system.

Information breakouts between exchange-traded and OTC derivatives

would also enhance supervisory understanding of a bank's liquidity

risk. Though both exchange and OTC markets contain liquid and illiquid

contracts, exchange-traded contracts are generally considered to be

more liquid. Given the margin requirement for exchange-traded contracts

and the potential liquidity constraints that could occur from large

positions in these instruments, this information would also enhance the

supervisory understanding of banks' funding risk.

Systemic risk is the risk that failure or default by a market

participant or group of participants will cause more widespread

disruption throughout the financial markets. A key to the assessment of

systemic risk is the identification of the exposure of individual banks

to specific markets. Therefore, the notional (or par) values of

exchange-traded and OTC positions by type would enhance supervisory

understanding of an institution's exposures to systemic problems that

might develop in a particular market.

The banking agencies believe that notional (or par) value data on

exchange-traded and OTC contracts are readily available in conjunction

with the bank's day-to-day management of derivative activities. This

information will assist the banking agencies in identifying for follow-

up action those banks that have significantly expanded their off-

balance-sheet activities, focused their off-balance-sheet activities in

a new direction, or have entered into derivatives activities that might

otherwise adversely impact the capital and liquidity of that

institution.

Fair Value Data

As discussed above, notional (or par) value data currently

collected provide insight as to the nature and extent of off-balance-

sheet derivative activities for both individual banks and across the

banking system. Off-balance-sheet derivative fair values would provide

valuable data for aggregate banking system and individual bank

comparison as to credit risk exposures and future cash flow and income

exposures, which may not be reflected on the balance sheet.

In conjunction with the notional (or par) value data summarized

above, positive fair value data, in combination with the negative fair

value data, would enhance insight regarding the bank's exposures to

systemic problems that might develop in a particular market.

Fair value data provide insight as to the credit exposure and

credit provided by the bank to the marketplace and therefore is also an

indicator of the bank's current vulnerability to potential problems in

the derivative markets. For credit risk purposes, the gross positive

fair value represents the maximum losses a bank could incur if all of

its counterparties defaulted and there was no netting of contracts or

underlying collateral. This is similar to the carrying value of a

bank's loans which represents the maximum loss the bank could incur on

its loan portfolio if all counterparties (borrowers) defaulted and the

loans were not collateralized. Such information is especially valuable

to supervisors when a bank is in danger of failure. In addition,

negative fair value data provide information about the market's

exposure to that bank.

Gross positive and negative fair value data highlight capital

exposures arising from off-balance-sheet derivative activities for

contracts accounted for on a hedge or accrual basis. For these

contracts, fair values would provide better information than currently

is reported on deferred or otherwise unrecognized gins and losses in

bank's balance sheet. These amounts reflect future contributions to or

demand on the bank's capital. This information will assist the banking

agencies in identifying for follow-up action those banks that have

significantly expanded their off-balance-sheet activities, focused

their off-balance-sheet activities in a new direction, or have entered

into derivatives activities which might otherwise significantly impact

the capital of that institution.

Banks with assets greater than $150 million are currently required

to disclose data regarding the fair value of their off-balance

contracts under Statement of Financial Accounting Standards No. 107,

``Disclosures about Fair Value of Financial Instruments'' (SFAS 107).

Under the FDIC's regulations implementing Section 36 of the Federal

Deposit Insurance Act, as added by Section 112 of FDICIA, insured

depository institutions with assets greater than $500 million are

required to file annual audited financial statements containing the

SFAS 107 fair value disclosures with the banking agencies. However,

this audited financial statement requirement may be satisfied for

subsidiaries of holding companies through audited financial statements

of the consolidated holding company. Thus, data in those consolidated

financial statements would not be available, for supervisory purposes,

on an individual bank basis. In addition, the methods used to calculate

or summarize the SFAS 107 disclosures may not be consistent from one

institution to the next.

For institutions subject to SFAS 107, fair value data are expected

to be readily available. In addition, the banking agencies believe

these data to be readily available for use by banks in the day-to-day

management of their derivatives activities.

Net Credit Exposure Data

The use of legally enforceable bilateral netting agreements which

provide protection in case of bankruptcy may significantly reduce the

credit risk exposure of bank's derivative positions. Most large banks

compute such netted exposures for internal credit risk management

purposes. These data would be collected in anticipation of a possible

change in the netting rules for risk-based capital purposes. In

addition, this information will provide a more accurate estimate of the

credit exposure from off-balance-sheet derivative contracts.

Income Statement Data

Current income statement reporting practices for off-balance-sheet

derivatives make it difficult to perform meaningful analyses of such

instruments. Analyses cannot be performed because the income statement

data for derivatives are combined with other, often unrelated amounts.

The memorandum disclosures proposed for off-balance-sheet derivative

income statement data would provide supervisory insight as to the

nature of such activities and about exposures to a bank's capital.

Reporting the income data related to off-balance-sheet derivative

contracts accounted for on a mark-to-market or LOCOM basis in a

separate memoranda item would provide an indication of the earnings

contribution of such activities in relation to other trading

activities. In addition, with the reporting of net interest income

amounts in separate memorandum items, the banking agencies will learn

the impact of such amounts on the net interest margin. When monitoring

such data on a period-to-period basis in comparison to changes in

market rates, these would provide supervisory insight as to the nature,

extent and effectiveness of off-balance-sheet derivatives used for risk

management.

Information reported in certain of the proposed memoranda items

would provide supervisory insight regarding the components and

variability of a bank's net interest margin. Monitoring these data over

time would provide better information on the sensitivity of a bank's

net interest margin to market rate changes and whether off-balance-

sheet activities have increased, decreased or stabilized the bank's

earnings.

Request for Comment

The FFIEC is requesting comment on all aspects of the proposed

revised reporting requirements for off-balance-sheet derivative

contracts, especially the availability of information, cost and time

required to implement these changes. In particular, the FFIEC solicits

comments on the following:

The FFIEC specifically requests comment on the availability of

notional (or par) value data separated between exchange-traded and OTC

contracts, the availability, on an individual bank basis, of fair value

data separated between off-balance-sheet contracts accounted for at

market value or LOCOM and contracts accounted for on a hedge or accrual

basis, and the availability of net counterparty credit exposure data.

The FFIEC requests comment on the feasibility of providing such data

for the September 30, 1994 Call Report. If the proposed effective data

for this reporting is not feasible, please comment on how soon

thereafter such data would be available.

In addition, the FFIEC requests information about the specific

methodologies used by banks to determine fair values of the various

types of off-balance-sheet contracts. To the extent such information is

available in annual financial statement disclosures made under SFAS

107, please provide a copy of such disclosures.

The FFIEC specifically requests comment on the availability of the

amounts of off-balance-sheet derivative income and expense associated

with contracts accounted for at market value or LOCOM and of the

amounts of off-balance-sheet derivative income and expense included in

net interest income. The FFIEC requests comment on the feasibility of

providing such data for the March 31, 1995 Call Report. If the proposed

effective date for this reporting is not feasible, please comment on

how soon thereafter such data would be available.

The FFIEC is proposing to collect information on income from two

broad categories of derivatives. The first category involves income

from derivatives that are accounted for on a mark-to-market or LOCOM

basis. The second category involves income from derivatives that are

accounted for on the hedge or accrual basis. Should the income and

expense associated with derivatives that hedge a balance sheet position

that is accounted for at market value or LOCOM be reported in the first

category or the second category?

The FFIEC seeks comment on whether information should be obtained

on the separate financial results of off-balance-sheet derivative

transactions which impact equity capital accounts rather than the

income statement. Please provide information about the nature and

extent of such activities in banks.

The FFIEC also invites comment on the use of $100 million in total

assets as the size threshold for requiring banks to provide the

proposed fair value, net counterparty credit risk and income statement

data in the Call Report. The FFIEC has considered combining the asset

size criterion together with a threshold considering the notional (or

par) value of the bank's outstanding off-balance-sheet contracts. Such

combined reporting criteria would focus on the bank's off-balance-sheet

risk exposure. The FFIEC requests comment on what amounts should be

used in such a combined threshold.

Interagency Policy Statement on Changes in Regulatory Reporting

Requirements

In May 1992, the FFIEC adopted a policy calling upon the agencies

to announce prior to the end of each year all reporting changes that

will take effect in the following year. Exceptions can be made to this

policy when a majority of the members of the FFIEC determines that

reporting changes are necessary for safety and soundness reasons. The

FFIEC has determined that the proposed changes to Schedule RC-L, which

would take effect as of September 30, 1994, are needed on safety and

soundness grounds as indicated in the preceding discussion on the

purpose of the additional data.

Paperwork Reduction Act

In accordance with the Paperwork Reduction Act of 1980 (Pub. L. 96-

511), the current Reports of Condition and Income required of all

insured commercial banks and FDIC-supervised savings banks have been

submitted to, and approved by, the U.S. Office of Management and Budget

(OMB). (OMB Control Numbers: for FDIC, 3064-0052; for FRB, 7100-0036;

and for OCC, 1557-0081.) The final version of the proposed changes that

are the subject of this request for comment, which will be developed

after consideration of the comments received, will be submitted by each

agency to OMB for its review.

The proposed changes to the Call Report are illustrated as follows:

Dated: March 3, 1994.

Joe M. Cleaver,

Executive Secretary, Federal Financial Institutions Examination

Council.

BILLING CODE 6210-01-M

TN09MR94.002

[FR Doc. 94-5378 Filed 3-8-94; 8:45 am]

BILLING CODE 6210-01-C