How Banks Finance and Account for Unmargined Derivative Gains
Summary
The document distinguishes balance-sheet accounting from a bank’s internal funding treatment of gains on unmargined OTC derivatives. One answer says banks commonly model the positive mark-to-market value as financed by unsecured borrowing. It gives two rationales: a hedged position may have a margined offsetting liability that requires cash, or an unhedged gain may increase equity, prompting an assumed adjustment to preserve the bank’s target capital structure.
A second answer clarifies that IFRS 9 does not require borrowing funds to recognize a derivative’s fair value on the balance sheet. It describes fair value recognition for derivatives and notes that valuation adjustments may be treated differently depending on collateralization. The discussion therefore separates an accounting entry from an internal funding cost assumption. It is brief and does not document regulatory detail, quantify funding costs, or establish that every bank uses the same internal convention.
Key ideas
- Banks may internally treat gains on unmargined derivatives as financed by unsecured borrowing.
- A margined hedge can create a cash funding need through its offsetting liability.
- An unhedged gain may be modeled with a capital structure adjustment.
- The document says IFRS 9 does not require borrowing to recognize fair value on the balance sheet.
- Internal funding assumptions and accounting recognition are distinct questions.
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Full text
# Does a bank borrow money to post the market to market valuation of assets to its ledger?
# Does a bank borrow money to post the market to market valuation of assets to its ledger?
If a bank owns an unmargined OTC derivative contract with mark to market valuation of \$X, is it required to borrow \$X from money markets in order to post that asset's value to its balance sheet? If so, what is the reasoning behind this requirement (rather than simply including the derivative's mark to market value on its balance sheet without needing to borrow that amount)?
I have read internal resources that imply this, but have not been able to find anything publicly available that confirms and explains this.
## Answer by dm63 (score 2)
https://quant.stackexchange.com/a/66668
Ok so let’s say we have an asset on the balance sheet which is the market value of an unmargined derivative. A common procedure by banks is to assume this is financed by unsecured borrowing. Why ? I suppose there are two cases (a) the derivative has been hedged with a margined contract going in the opposite direction. In this case the margined contract is a liability, for which the bank has to raise cash. Thus, we have a requirement for unsecured borrowing. Or, (b) (less likely) the contract was unhedged, so it represents a pure gain . In this case, the balance sheet reflects this gain by an increase of retained earnings within shareholder equity. However one assumes that the bank will maintain its desired capital structure at a certain ratio , so in the end the bank will repurchase some equity and instead take out unsecured borrowing , as before.
So yes, gains on unmargined derivatives are generally financed by unsecured borrowing and are internally costed as such.
## Answer by simzoor (score 2)
https://quant.stackexchange.com/a/66677
From a pure accounting perspective under IFRS 9, there is no requirement like this for putting it on the balance sheet.
Every derivative, regardless of margined or unmargined, gets posted to the balancesheet to its Fair Value. For uncollateralised derivatives, this means $FV = MtM("riskless") - XVA$, while for collateralised derivatives, it is best practice to neglect $XVA$.Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.