[Federal Register Volume 59, Number 46 (Wednesday, March 9, 1994)] [Unknown Section] [Page 0] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 94-5378] [[Page Unknown]] [Federal Register: March 9, 1994] ======================================================================= ----------------------------------------------------------------------- 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