Notional Amounts Aren't Real
The Age
Wednesday November 12, 2008
THE article "Banks face challenge on off-balance sheet exposure" (BusinessDay, 4/11) contains several inaccuracies and misrepresents the nature of Australian banks' exposure to derivatives activities.
The $13.8 trillion in off-balance sheet business reported in the RBA Bulletin for June 2008 is not a measure of banks' exposures, as suggested by the article. It is an activity measure that aggregates the "notional" or face value of derivatives contracts. This is not the amount banks are actually required to pay or be paid. Around one-third of this activity is generated by foreign banks operating in Australia.Most derivatives exposures (well over 90% in terms of notional amounts) arise from exchanged-traded derivatives, or "plain vanilla" interest rate swaps and foreign exchange contracts that banks use to hedge other exposures on their balance sheets. In APRA's view, it would be imprudent for banks not to use derivatives to hedge risks inherent in their banking business.The appropriate measure of banks' credit risk on derivatives is the "credit equivalent amount". This is any positive market value of the derivative (the current amount owed by the counterparty on the transaction over its lifetime at current rates) plus a regulatory add-on for potential future changes in this value. APRA and other regulators around the world use this value to calculate regulatory capital requirements. At June 2008, the credit equivalent amount from Australian banks' off-balance sheet business was only a fraction of the notional figure.The statement that "Australian banks may be forced to bring billions of dollars in 'off-balance sheet' exposures onto their balance sheets because of the growing risk of counterparty failure" is simply wrong. Under IFRS, which has been in effect since 2005 in Australia, such exposures are not "off-balance sheet" and are fully reflected in balance sheets and regulatory capital adequacy requirements.Stuart Snell, Head of Public Affairs, APRAEmail letters to mshort@theage.com.au
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