Federal Agency Proposes Regulations for Derivatives

The federal agency that regulates national banks is proposing new rules requiring that these financial institutions put aside more cash to cover potential losses on long-term derivatives contracts.

The Comptroller of the Currency is to publish the proposed regulations today in the Federal Register, opening up the changes to public debate through Oct. 21. The rules are similar to those proposed by the Federal Reserve Board, the agency that regulates bank holding companies and state-chartered banks that are members of its system.

Derivatives are securities whose returns are tied to the value of one or more assets, such as stocks, bonds, interest rates or currencies, or indexes based on their value. They tend to be extremely volatile.

Both the Comptroller of the Currency and the Fed would require banks to increase their capital requirements for derivatives contracts of five years or more that are tied to equities, precious metals and commodities.

The rules would amend the Basel Accord passed in July, which regulates contracts tied to interest rates and foreign exchanges. “If banks do experience losses, they have a larger cushion to fall back on,” said Janis Smith, a spokeswoman for the Comptroller of the Currency.

The American Bankers Assn. does not oppose the rules, because few banks are active in the long-term derivatives contracts, ABA spokeswoman Stephanie Mullin said. “The overall effect on banks under the new rules will be limited,” she said.

However, some banks recently have voluntarily infused millions of dollars into short-term derivatives contracts that have been included in mutual funds sold to investors.

For instance, Fleet Financial Group a week ago announced it would inject $5 million into its money market funds to prevent investor losses.

Several bills aimed at regulating derivatives contracts have been introduced in Congress, including one by the House Banking Committee Chairman Henry Gonzalez (D-Tex.).

Gonzalez’s committee says that although the proposed regulations are a step in the right direction, the industry still needs legislation.

“Although derivatives are highly volatile and at times risky, in the pursuit of profit, banks may choose to downplay the risks involved,” Gonzalez said. “Regulators, bending to their banking constituencies, might also be convinced to cut regulatory corners.”