Community bankers are cautiously awaiting the outcome of a federal decision on whether to relax restrictions on who may sell agricultural trade options.
The Commodity Futures Trading Commission, the agency that regulates the commodities market, is considering whether to allow the sale of grain, oilseeds, cotton, and livestock op-tions outside a formal exchange. Under current rules, those options may be sold only through organized, national exchanges.
If the futures commission relaxes its rules, other parties involved in the agriculture industry, such as grain elevators and banks, may be allowed to write their own options and customize the contracts to better meet expected delivery dates, crop sizes, and prices.
Farmers have traditionally used trade options to minimize their risk. Options contracts grant the producer the right, but not the obligation, to buy or sell a commodity at a certain price based on which direction they expect the price to go in the future. If the right is not exercised by a certain date, the option expires and the farmer forfeits only what he paid to purchase the contract.
Mark Scanlan, agriculture representative for the Independent Bankers Association of America, said the options sold off-exchange have been presented as another way that farmers would be able to hedge risk.
"In light of the Farm Bill, we're ushering in an era where the farmer has to take more responsibility for risk," he said. The Farm Bill, which became law in April 1996, eliminates over time the price supports that many producers historically have received from the federal government.
Representatives from several community bankers' associations in large agricultural states said they have not yet discussed with their members how a commission rule change would affect the agricultural banks' operations. The IBAA also has not decided whether it should support the sale of agricultural trade options off the exchanges.
"It's an issue that we're going to be taking a closer look at," Mr. Scanlan said. "The process is just beginning."
A bank's risk may increase with the advent of off-exchange options contracts, if their farm customers purchase options contracts from disreputable salespeople or if the clients engage in pure speculation. Other bank customers, such as elevators, may also sell risky options contracts and overextend themselves. And the bank itself may incur risk if it writes options.
At the same time, off-exchange options contracts could also minimize a bank's risk. If a bank sold agricultural trade options contracts to producers, processors, and elevators, the bank would be assured that its clients have adequately hedged their risk. In turn, the bank could protect itself by hedging its risk on a traditional exchange.
Although the banking trade groups have yet to take a stand on the trade options issue, some individual banks are beginning to take notice. John H. Colvin, president and chief executive at North Salem (Ind.) State Bank, said he has discussed off-exchange options with a few farmers in his community. "Our initial reaction was it was OK," he said.
CoBank, an $18.5-billion-asset cooperative bank based in Denver, suggested that ifthe sale of off-exchange trade options is allowed, the Futures Commission should establish a system under which such options dealers would have to register, meet minimal capital requirements, and provide audited financial statements to the agency.
"You're going to have all kinds of people selling these products," said Jack Cassidy, a senior vice president at CoBank. "The lenders are going to have to take a closer look" at customers' financial plans.
Other observers have suggested that the commission establish a one- to three-year pilot to test whether off-exchange agricultural trade options sales would work in the general public.
Although banks themselves may be allowed to write agriculture trade options for their clients, Mr. Colvin said his $65-million-asset bank probably would not participate directly, even if it could.
He said the bank's leaders are conservative; they remember that some banks were held partially responsible for farm failures in the 1980s because the lenders reportedly advised customers on how to hedge their risk.
"We all got burned and scared away from it," he said. "I think we're cautious by nature, and we still feel the sting of 10 to 15 years ago."
The futures commission is reviewing the letters and testimony it has collected on the issue. Following its review, the agency will make a recommendation whether to revise its rules and will take further comments, a spokesman said.