Prudential supervision of banks' derivatives activities

Introduction

The report considers risks arising from derivative activities, defined as financial contracts whose value depends on a reference rate or the value of an underlying asset or index. Their prime purpose is to transfer risks associated with fluctuations in factors such as interest rates, exchange rates, and the prices of equities and commodities more efficiently. Derivatives comprise, inter alia, futures and forwards, swaps, options and instruments with similar characteristics. Derivatives are a sub-set of off-balance-sheet contingencies and commitments. The traditional off-balance-sheet items not treated as derivatives in this document include credit substitutes, such as acceptances, guarantees, letters of credit, forward asset purchases and general commitments to lend (including standby facilities and credit lines). The credit risk arising from both classes of off-balance-sheet items were addressed in the 1988 Capital Accord.

8. This report is structured as follows:

• the first section describes the past work of the Basle Committee which has had an effect on banks' derivative activities;
• the second section records a number of different projects currently in train, all of which address more or less directly the risk of derivatives activities;
• the third section addresses issues relating to banks' management and control of derivatives risk;
• the fourth section briefly reviews concerns about payments and settlement issues;
• the fifth section briefly discusses reporting, accounting and disclosure issues.