|For immediate release|
Interim Guidance on the Regulatory Reporting
and Capital Treatment for Derivatives
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133). FAS 133 provides comprehensive guidance on accounting for derivative instruments, including certain derivatives that are embedded in other contracts, and hedging activities.
Under FAS 133, banks, bank holding companies, and savings associations (collectively, banking organizations) must recognize all derivatives as either assets or liabilities on the balance sheet at fair value. If certain conditions are met, a derivative may be specifically designated as a "fair value hedge," a "cash flow hedge," or a "foreign currency hedge." The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. Derivatives used for trading or not qualifying as a hedge will continue to be marked to fair value, with changes in fair value recognized in current net income.
FAS 133 defines the three types of hedges as follows:
In addition to the accounting designation for hedges, FAS 133 requires that institutions separately account for certain types of embedded derivatives. Specifically, embedded derivatives that are not "clearly and closely related" to the economic characteristics and risks of the instruments in which they reside must be separated from the host instrument and reported separately on the balance sheet as a derivative. FAS 133 provides guidance on determining whether an embedded derivative is "clearly and closely related."
FAS 133 raises several important regulatory issues. This interim guidance explains the appropriate regulatory reporting and capital treatment of derivatives after a banking organization adopts this new accounting standard.
Interim Regulatory Reporting Treatment
Under FAS 133, changes in the fair value of most derivatives will be reflected in net income. However, for derivatives that qualify as cash flow hedges, the accumulated gains (losses) on these derivatives, to the extent the hedges are effective, initially will be recorded in a separate component of equity capital (accumulated other comprehensive income).
The Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency have proposed a modification of the Call Report and FR Y-9C forms in March of 1999 to capture the amount of accumulated net gains (losses) on cash flow hedges in a separate line item on the balance sheet. In the interim, however, banks and bank holding companies that adopt FAS 133 should report any accumulated net gains (losses) on cash flow hedges on the same balance sheet line item that is currently used to report "Net unrealized holding gains (losses) on available-for-sale securities" (Schedule RC, item 26.a, for banks and Schedule HC, item 27.e, for bank holding companies). In addition, any year-to-date changes in the accumulated net gains (losses) on cash flow hedges should be reported on the same line item that is currently used to report the "Change in net holding gains (losses) on available-for-sale securities" (Schedule RI-A - Changes in Equity Capital, item 11, for banks and Schedule HI-A, item 13, for bank holding companies).
In September 1998, the Office of Thrift Supervision changed the instructions to its TFR to accommodate reporting consistent with FAS 133, for 1998 and beyond. Pursuant to those instructions, savings associations that have adopted FAS 133 should report any accumulated gains (losses) on cash flow hedges on the same balance sheet line that is currently used to report "Other components of equity capital" (Schedule SC, line SC890). In addition, any quarter-to-date changes in the accumulated gains (losses) on cash flow hedges should be reported on the same supplemental information line that is currently used to report "Other adjustments" (Schedule SI, line SI670).
Interim Guidance on the Regulatory Capital Treatment
The different accounting treatment for fair value hedges and cash flow hedges may also have an effect on regulatory capital ratios as described below.
Fair Value Hedges
Risk-weights for Derivative Instruments
The existing risk-based capital treatment for derivatives remains in effect. In other words, the fact that an institution records a derivative on its balance sheet under FAS 133 will not change the way in which that derivative is risk-weighted for regulatory capital purposes. The amount to be included in risk-weighted assets for a derivative will continue to be based on the credit equivalent amount of the derivative, not the on-balance-sheet fair value.
1 The credit equivalent amount of a derivative equals the fair value of the derivative (if it is positive) plus an additional amount for the potential future credit exposure. The potential future credit exposure additional amount is the notional amount of the derivative multiplied by a credit conversion factor which depends on the remaining maturity and type of contract, e.g., interest rate, foreign exchange, or equity.
2 The risk weight is determined by criteria listed in each agency's risk-based standards and depends, in part, on the type of counterparty.
1998 Banking and consumer regulatory policy