OCC reports increase in derivatives notionals, but notes decrease in trading earnings

Derivatives held by US commercial banks increased by $3.1 trillion in the third quarter 2002, to $53.2 trillion, the US Office of the Comptroller of the Currency (OCC) said in its quarterly report. But the OCC also reported that earnings attributable to the trading of cash instruments and derivatives activities decreased by $1 billion in the three-month period, to $2.4 billion.

During the third quarter, the notional amount of interest rate contracts increased by $3 trillion to $45.7 trillion. Foreign exchange contracts increased by $27 billion to $5.8 trillion, excluding spot foreign exchange contracts, which increased by $5.7 billion to $509 billion. Equity, commodity and other contracts increased by $6 billion to $1.1 trillion. Credit derivatives increased by $81 billion, to $573 billion.

However, revenues from interest rate positions decreased by $329 million to $1.2 billion, and revenues from foreign exchange positions decreased by $315 million to $1 billion. The OCC also found that revenues from equity trading positions decreased by $662 million, for a loss of $172 million. But revenues from commodity and other trading positions increased by $304 million to $278 million.

"Normally, a significant increase in notionals would translate into a stronger revenue picture," said Kathryn Dick, the OCC's deputy comptroller for risk evaluation. “But financial market volatility in the third quarter dampened the revenue picture for some of the bank dealers."

Dick also noted that while the record notional amount of derivatives is a reasonable reflection of business activity, it does not represent the amount at risk for commercial banks. The risk in a derivatives contract is a function of a number of variables, such as whether counterparties exchange notional principal, the volatility of the currencies or interest rates used as the basis for determining contract payments and the creditworthiness of the counterparties in the transaction, Dick added.

Total credit exposure, which consists of both the current mark-to-market exposure, as well as potential future exposure, increased $45 billion to $570 billion, the OCC found.

"At this point in the economic cycle, we are not surprised to see increased credit exposure," said Dick. “But the assessment of risk must take into consideration the common use of credit risk mitigants such as netting and collateralisation in the derivatives markets." Indeed, Dick said the benefits achieved from legally enforceable bilateral netting reduced current credit exposures by 79.6%in the third quarter.