FED DRAFTS CURRENCY, RATE SWAP RISK GAUGE The Federal Reserve Board voted unanimously to propose a formula for calculating the risk of interest rate and currency swaps as part of its ongoing effort to come up with a new capital standard for U.S. banks that takes into account the riskiness of a bank's loans and other assets. Fed officials said an identical proposal was being issues today by the Bank of England. The Fed set a 60-day period for public comment on the plan. The proposal adopted today addresses only the credit risks associated with interest rate swaps, forward foreign exchange contracts and similar financial instruments. Previously, the Fed Jan. 8 proposed a series of guidelines for calculating the risk of other off-balance-sheet activities that banks would be required to take into account in calculating the minimum financial cushion they would need to maintain. Both guidelines set five broad categories of risk for loans and other bank assets and assigned to each a level of risk that would establish a bank's minimum capital needs. The additional guidelines proposed today would determine the amount of capital support required for a bank's current exposure for a given asset and the potential future exposure. The current exposure would be measured by the mark-to-market value of the asset, which would reflect the replacement cost. Potential future increases in the replacement cost would be calculated using credit conversion factors based on statistical analyses by the staffs of the Bank of England and U.S. banking regulators. Future exposure would rise over the life of the asset. The Fed staff said the risk gauge attempted to balance conflicting needs for precision and simplicity. They ignore, for example, the relative volatility of the particular currencies involved in exchange rate contracts. Board officials said the new gauge could increase the capital required of the largest money center banks, which are the principal participants in these types of activities. They cautioned the Fed board to take account of the potential impact of the plan on the ability of U.S. banks to compete in world financial markets. However, the staff concluded, "The credit risks inherent in such contracts now constitute a significant element of the risk profiles of some banking organizations." The Fed proposal would exempt all but the 20-25 largest participants in this market, on grounds the benefits of including the smaller banks would be outweighed by costs. Also excluded would be interest rate and foreign exchange contracts traded on organized exchanges. Governor Martha Seger said she was concerned that Japan was not involved in the U.K.-U.S. effort to draft new capital rules.