Buried deep within a draft accounting rule is a requirement that could increase banks' reliance on derivatives.

The draft proposal that Financial Accounting Standards Board is considering - about transfer of assets and extinguishment of liabilities - includes a change in the way banks account for longer-term repurchase agreements.

Approval of that provision could lead to more use of off-balance-sheet instruments by banks trying to match maturities on their assets and liabilities.

The draft, which is expected to reach the stage of formal proposal next month and be adopted by mid-1996, deals with the accounting treatment of modern financial instruments such as asset securitizations, loan participations and syndications, bankers acceptances, and repurchase agreements.

In the portion of the draft dealing with repurchase agreements, the board proposed to record as sales any transactions that unwind more than 90 days after initiation. And this has some analysts worried about disruption of the estimated $1 trillion repo market.

"I'm unconvinced that the repo market has had some kind of fatal flaw that would have caused this kind of action to be taken," said Fred D. Price, a principal at Sandler O'Neill & Partners. "If you think about the ramifications and limitations this rule would subject financial institutions to, it means that derivatives will have to play a much bigger role in their asset/liability management."

Halsey Bullen, project manager on this proposal for the FASB, said the goal is to give consistent treatment to a variety of transactions.

The current set of rules affecting asset transfers has created a situation where companies give similar transactions different accounting treatment, he went on to say. With this "hodgepodge" of rules, it is difficult for investors and analysts to compare securities accurately.

Despite the board's desire to focus on which party controls the assets, this version of the draft incorporated an exception for repurchase agreements that would continue to treat these transactions as on-balance- sheet financings if they meet three conditions. Otherwise, the transactions would be treated as asset sales.

The first of these conditions is that the transactions must be highly collateralized, making them different from off-balance-sheet forward contracts. Second, the value of the collateral has to be adjusted so that, in a default, the original seller will be able to buy the securities on the open market. And finally, the agreement must unwind in 90 days or less.

Mr. Bullen said the time limits were chosen because a study by the New York Clearing House Association showed that most repos mature in less than three months.

But Carlos Mello, senior vice president and comptroller with Peoples Bank in Bridgeport, Conn., and a member of the committee reviewing this draft for America's Community Bankers, said there is a viable funding market for institutions beyond the 90-day mark.

"I think (the FASB proposal) takes away a very attractive market for financing and will ultimately force banks and others to extend credit on shorter terms," he said. "That limits the economic ability of consumers and others to borrow in longer-term increments."

As it stands, the draft would also force banks to classify securities used in this type of transaction as "available for sale," said Joe Longino, another principal at Sandler O'Neill. Ultimately, the rule could force commercial banks into the derivatives market more often.

"It's limiting the options available to depository institutions at a time when they need better options," Mr. Longino said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.