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1 [1] (October 17, 2024)

handle is hein.crs/goveqzm0001 and id is 1 raw text is: Derivatives Trading in U.S. Banking October 17, 2024 Overv ew Bank derivative holdings are highly concentrated among large banks, with large banks holding 97.9% of the notional amounts of bank derivative holdings. This level of concentration holds across all asset classes of derivatives. A September 2024 Office of the Comptroller of the Currency report noted that the four banks with the most derivative activity hold 88% of all bank derivatives. Since the financial crisis of 2008, regulators and academics have grappled with whether, and to what extent, a concentration of derivatives trading within large banks contributes to systemic risk. The concern about too big to fail banks has also translated into concern over too interconnected to fail banks-wherein banks may also be systemically important because of their prominence in financial activities, such as derivatives trading. Separately, in 2023, a series of regional bank failures (involving Silicon Valley Bank, First Republic Bank, and Signature Bank) raised questions over whether banks-especially medium-size ones-sufficiently used derivatives to hedge the interest rate risk that contributed to the 2023 bank failures. This episode raised a different concern-that the failure to use derivatives to hedge rate risk by the failed banks had contributed to systemic risk. Background Derivatives are financial instruments that derive their value from the price of an underlying asset or index. Broadly, there are three types of derivatives: futures, swaps, and options. Swaps may be traded bilaterally, often between two financial entities or through a regulated clearinghouse. Futures and options are traded on regulated exchanges and cleared through clearinghouses. Derivatives markets are highly interconnected with the financial system. Major swap dealers are often affiliates of large banks. Some argue that, as a result, the failure of a swap dealer or the dealer's client could impact its trading counterparties and potentially spread losses through the financial system. High concentration of derivatives activity among a few large banks can also mean that severe price dislocations- such as the sharp spikes in wheat and natural gas prices following the 2022 Russian invasion of Ukraine-could drain liquidity from the financial system, by leading to sudden large calls for margin to cover accumulating losses. In 2022, for example, the combination of high concentration of derivatives activity and strong interlinkages among such financial firms amid market volatility highlighted financial system vulnerabilities. Concentration of Derivadves o d ngs Every quarter, U.S. banks are required to file Consolidated Reports of Condition and Income, known as call reports, with their primary regulators. A call report describes the bank's financial state and includes an accounting of the derivative contracts to which the bank is party. This accounting includes the underlying assets or benchmarks for the derivatives, the type of derivatives being used (e.g., future, option, swap), and whether the derivatives are exchange-traded. By analyzing the data from all 4,594 call reports filed on June 30, 2024, CRS has identified several characteristics of bank derivative activities. Quantities of derivatives can be expressed either in terms of fair value-meaning the market value of the contracts-or in terms of notional amount-meaning the total value of the underlying assets in a contract. A notional amount is typically much larger than the fair value of a contract. The total notional value of a bank's derivatives can be greater than its assets. Figure I. Bank Derivative Holdings Are Highly Concentrated Among the Largest Banks Category: Top Four U All Other Large Medium I Small Source: CRS analysis of Federal Financial Institutions Examination Council (FFIEC) bulk call report data from June 30, 2024. Notes: The top four holders of bank derivatives are, in descending order, JPMorgan, Goldman Sachs, Citibank, and Bank of America. Small bank derivative holdings are 0.10% of overall holdings. For the purposes of this report, large banks are those with more than $250 billion in total assets, medium banks are those with between $5 billion and $250 billion, and small banks are those with less than $5 billion. Table I. Large Banks Hold More Derivatives Relative to the Size of Their Assets Share of Total Notional Bank Size Share of Total Derivative Category Bank Assets Amounts 57.7% 97.9% Large

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