KARACHI - After witnessing momentous growth over a couple of years, the financial derivative business of the banks declined by 3 per cent during the second quarter (April-June) of current calendar year, 2009 amid contraction in foreign currency option and cross currency swap portfolio. The outstanding notional amount of all derivatives products reached to Rs250b during the April-June 2009. This sector posted 11 percent and 17 percent decrease in Mar-09 and Dec-08 quarters respectively, giving a 31 percent decline since corresponding quarter of last year. SBP break-up of Derivative Business, compiled by SBP showed that the most significant decline was observed in Foreign Exchange Options (FX Options) which declined by 54 percent over the quarter (88 percent in YoY basis) to Rs11 billion and their relative share declined to around 4pc by the end of Jun-09. The FX Options now have the lowest share in banks derivative portfolio as compared to leading share during the first quarter of last year. Cross Currency Swaps (CCS) constitutes the largest share of banks financial derivates portfolio. After witnessing an increase during the last quarter, the value of CSS marginally declined by 2.3pc during the quarter under review to Rs164 billion. The leading factor behind the popularity of CCS has been the high gap between domestic and international interest rates. The high interest rate differentials have induced the local corporate, particularly those with sufficient export volumes, to swap their local currency exposures with EURIBOR or LIBOR. Interest Rate Swaps (IRS) 23 which experienced a significant decline in last quarter increased by 11 percent during April-June 2009 to Rs76 billion. In line with changes in customers expectation of interest rate scenario, the volume of the IRS has changed over time. YoY basis their value has shrunk by 24 percent and now these contracts are the second major component of banks overall financial derivative portfolio. All Forward Rate Agreements (FRAs)24 which were a recent phenomenon in Pakistani derivative market matured or cancelled during last quarter and the quarter under review witnessed no activity in FRAs. Nevertheless, their share had remained negligible in the value of total outstanding derivatives transactions. The outstanding financial derivatives transactions pertain to eight banks including five ADDs. These banks belong to different banking group: 5 LPBs, 2 FBs and a PSCB. The mark-to-market position shows slight improvement over the quarter. Total mark-to-market losses during the quarter under review declined by 10 percent to Rs10.6 billion (Rs11.7b in Mar-09 and Rs10.4b in Dec-08). These mark-to-market losses come to around 3.3 percent of the equity of banks engaged in derivate business and 3.0pc of outstanding notional principal amounts. Disaggregated analysis shows that four banks are carrying mark-to-market losses on their derivative portfolio. A couple of banks have significantly risky exposures as reflected by high percentages of mark-to-market losses; these banks could face further stresses in case of any further adverse movements in underlying prices.