[Federal Register Volume 59, Number 46 (Wednesday, March 9, 1994)]
[Unknown Section]
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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]


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FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL

 

Disclosure of Off-Balance-Sheet Derivatives

AGENCY: Federal Financial Institutions Examination Council.

ACTION: Request for comment.

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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