When banks use derivatives, they typically go to the over-the-counter market looking for interest rate contracts, according to a report on the use of derivatives by banks.

The report by the Office of the Comptroller of the Currency said the notional value of interest rate contracts held by banks was nearly twice that of foreign exchange and other contracts combined at the end of the first quarter.

The 25 largest derivatives users reported $10.7 trillion of interest rate contracts outstanding at quarter's end, accounting for 63.4% of their total outstandings. Foreign exchange contracts accounted for 34.5% of the total; other contracts, the remaining 2.1%.

Derivatives are financial contracts, often used to hedge business risks, whose value is based on underlying benchmarks such as currency prices or interest rates. The report underscored the importance of interest rate sensitivity in banks' portfolio strategies.

For the 596 smaller derivatives-using banks, the concentration in interest rate contracts was even more pronounced, accounting for 89.6% of the $515.2 billion in open derivatives contracts. Foreign exchange accounted for the bulk of the remainder, at 9.9%; other contracts, 0.5%.

The report said the over-the-counter market accounted for 83% of all derivatives contracts banks reported holding at March 31.

The nine biggest users differed significantly from the remainder of the top 25 in only two categories.

While the Big Nine had 40.1% of their contracts in the forward market, compared with 6.9% in exchange-traded options, the next 16 banks put less emphasis on the forward market - 32% - and more on options available at exchanges - 13.3%.

The other 596 banks reported having more than 85% of their open derivative contracts at March 31 coming from the over-the-counter market. Swaps were the most popular instrument with this group, accounting for a collective 56.5% of their derivatives contracts; OTC options made up another 20.8%.

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