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Financial Institution Letters

Basel Committee on Banking Supervision
Capital Accord

FIL-4-99, Attachment
January 21, 1999




1   If certain other conditions are met, a derivative may be specifically designated as a "fair value hedge" or as a hedge of the foreign currency exposure of a net investment in a foreign operation. In these situations, the gain or loss on the derivative is reported in a different manner than the gain or loss on a derivative used in a cash flow hedge. If a derivative is not designated as a hedging instrument, the gain or loss on the derivative is recognized in current earnings.

2  Generally, the objective of a cash flow hedge is to link a derivative to an existing recognized asset or liability or a forecasted transaction with exposure to variability in expected future cash flows, e.g., the future interest payments (receipts) on a variable-rate liability (asset) or a forecasted purchase (sale). The changes in cash flows of the derivative are expected to offset changes in cash flows of the hedged item or transaction. To achieve the matching of cash flows, FASB Statement No. 133 requires that changes in the fair value of properly designated and qualifying derivatives initially be reported in a separate component of equity (accumulated other comprehensive income) and reclassified into earnings in the same future period that the hedged transaction affects earnings.

3  The effective portion of a cash flow hedge can be described as the change in fair value of the derivative that offsets the change in expected future cash flows being hedged. Refer to FASB Statement No. 133, Appendix A, Section 2, for further information.

4  Organization costs for a bank are the direct costs incurred to incorporate and charter the bank. Such costs include, but are not limited to, professional (e.g., legal, accounting, and consulting) fees and printing costs directly related to the chartering or incorporation process, FILing fees paid to chartering authorities, and the cost of economic impact studies.

Last Updated 07/17/1999 communications@fdic.gov

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