Credit risk for banks holding derivatives declined in 1995.

A report by the Office of the Comptroller of the Currency (OCC) says the credit exposure for banks holding derivatives continued to decline. The credit exposure from derivatives dropped from 336% of risk-based capital in the first quarter of 1995 to 250% in the fourth. Overall credit exposure from off-balance-sheet contracts fell by $12 billion to $228 billion over the same period, according to the report. A derivative is a financial contract whose value is derived from the performance of assets, interest rates, currency exchange rates or indices.

Dorsey L. Baskin, national technical director for financial institutions at Arthur Andersen in Washington, D.C., and member of the American Institute of CPAs banking and savings institutions committee, said his risk management consulting practice continued to see a lot of interest. "We have customers who want new risk management tools, such as software, or need to restructure their organizations to integrate better risk management," said Baskin.

The OCC report attributed the decline to a reduction in interest rates and other market volatilities, as well as banks' continued use of bilateral netting--an arrangement between a bank and another entity that creates a single legal obligation for all individual contracts. "This report reflects continued improvements either in risk management tools or market conditions or both," said Baskin.

The number of banks holding derivatives declined by 37 in the fourth quarter to 558 banks. However, the top nine banks holding derivatives account for 94% of all U.S. derivatives activity. The report also said the notional amounts of derivatives in commercial bank portfolios decreased by $778 billion in the fourth quarter to $16.86 trillion in holdings. "Notional amounts are helpful in measuring the level and trends of derivatives activity," said the OCC report, cautioning, though, that they were a misleading indicator of risk exposure. Baskin said that notional amounts should not be equated with risk because they do not include the contract terms, such as duration or the interest indices.

The number of banks reporting high-risk mortgage securities decreased by 36 to 569 during the fourth quarter, while the number reporting structured notes was 4,273, a decline of 110 in the fourth quarter.

The OCC charters, regulates and examines approximately 2,800 national banks and 70 federal branches and agencies of foreign banks in the United States.

Concentration of Derivatives Contracts Top Nine Banks Hold

Futures & forwards..................41.8%
Swaps...............................32.4%
Options.............................19.4%
Total...............................93.6%

Source: The Office of the Comptroller of the Currency

Decline in Risk-Based Capital

First quarter 1995.................336%
Fourth quarter 1995................250%

Source: Comptroller of the Currency