(44) Financial derivatives

Derivatives are financial instruments defining prices and maturities by reference to an underlying instrument. Derivatives may be interest rate contracts, foreign exchange contracts, equity-related and other instruments. Within the “other derivatives” category, the significance of credit derivatives has grown in the past years. Derivative transactions may be concluded over the counter (OTC), i.e. directly with the counterparty, or via exchanges. The exposure is reduced by a margin which must be deposited for exchange-traded contracts (futures and options) to absorb current price fluctuations.

In this business category, notional amounts provide relatively little information on default risk. Amounts receivable or payable under derivatives are reflected in their fair values.

Derivatives are mainly used for trading purposes. Market participants include banks (proprietary trading), securities houses, mutual funds, pension funds, and corporate customers. Customers can use these instruments to hedge risk positions against unfavourable price fluctuations and, depending on the strategies pursued by customers, they can benefit from changes in prices, exchange rates and interest rates.

Bank Austria Creditanstalt also uses derivatives for hedging proprietary positions in the banking book and for asset/liability management purposes. The bank hedges proprietary interest-rate and currency positions, and uses credit derivatives to protect its credit risk positions against credit rating fluctuations. Asset/liability management ensures the appropriate maturity structure of interest-bearing balance sheet positions. The bank also performs exchange rate management in respect of equity positions in foreign currency.

The total volume of derivative instruments declined from € 842 bn at the end of 2004 to € 663 bn at the end of 2005. Interest rate derivatives, especially interest rate swaps, forward foreign exchange outright transactions and swaps as well as cross-currency swaps again accounted for the largest proportion of total volume. Trading volume within these categories declined, mainly because of a shift in BA-CA’s strategy away from active market making in derivatives. This change is to be seen in the context of the banking group’s overall activities in the market. On the other hand, growth was recorded in equity and equity-index instruments, which increased by € 1,021 m, and in credit derivatives.

Bank Austria Creditanstalt made more intensive use of these transactions for hedging banking book positions.

For the purposes of portfolio and risk management, counterparty risk of OTC derivatives is taken into account with the respective positive market value and an add-on depending on the product, currency and maturity. Add-ons applied in internal credit risk management for the potential future exposure are based on the current market volatility relative to the remaining period to maturity of the transaction as well as on additional considerations with respect to stress events. Given the underlying confidence interval of 97.5%, these add-ons are in most cases clearly above the relevant levels pursuant to the Austrian Banking Act.

Line utilisation for derivatives business is available online in WSS (“Wallstreet”), the central treasury system, on a largely Group-wide basis. For smaller units not connected to the central system, separate lines are allocated and monitored. Group-wide compliance with lines approved in the credit process is thus ensured at any time.

Bank Austria Creditanstalt additionally limits the credit risk arising from its derivatives business through strict use of master agreements, the definition and ongoing monitoring of documentation standards by legal experts, and through collateral agreements and break clauses. In combination with the very good average credit rating of our business partners in the derivatives business, management takes proper account of default risk despite a significant increase in business volume.