Banks are utilizinga footnote found in a 2013 regulatory document to ease the burden of new capitalrules, The Wall Street Journal reportedApril 7.
The referencein the footnote allows banks to hold less capital against shorter-term derivatives,which are particularly useful to banks when they enter into longer-term contracts.
The footnote,numbered 151 and located on page 79 of a regulatory document entitled "RegulatoryCapital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy,Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weightedAssets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-BasedCapital Rule, and Market Risk Capital Rule," reads that for "a derivativecontract that is structured such that on specified dates any outstanding exposureis settled and the terms are reset so that the market value of the contract is zero,the remaining maturity equals the time until the next reset date. For an interestrate derivative contract with a remaining maturity of greater than one year thatmeets these criteria, the minimum conversion factor is 0.005."
In effect, theJournal explains, banks are structuringdeals such as a 10-year contract, as a series of swaps that settle every day.
FDIC Vice ChairmanThomas Hoenig frowns on the practice, however, stating in an interview that companiesthat do this "are trying to get around a leverage constraint" and are"gaming the system," the Journalreported.
Big banks alsosat down with regulators in a meeting organized by the Securities Industry and FinancialMarkets Association so that the practice could be explained and receive feedback,the news outlet reported, citing "people familiar with the matter." Amongthe banks involved were Citigroup Inc.,JPMorgan Chase & Co.and Bank of America Corp.,along with the Federal Reserve and the FDIC on the regulatory side, sources forthe report added.
The news outletalso cited a statement sent to it by the OCC stating that the practice "raisesserious safety and soundness concerns." The OCC is also assessing the use andimpact of the footnote's reference in determining if a "supervisory response"is warranted.