The Farm Credit System, the largest single lender to U.S. agriculture, is likely to stay free of most government regulations tied to the sweeping Dodd-Frank market reforms when the Commodity Futures Trading Commission decides on swaps rule-making at a meeting on Wednesday, banking industry sources say.

Bankers are fuming at the prospect.

With more than $230 billion in assets, the Farm Credit System - a government-sponsored entity or GSE - is not likely to be deemed a "swap dealer" since its swap deals with customers are not big enough to meet a minimum threshold for players who might pose a systemic risk, they say.

The decision will turn on the fact that only a fraction of the $37 billion in swap agreements that Farm Credit has on its books are not directly related to market hedges.

Of that "notional" value for swaps on its books as of Dec. 31, 2011, only about $3 billion was outstanding that related to swap agreements the lender offered to its own customers. The rest were common interest-rate swaps that Farm Credit uses to hedge and manage interest-rate exposure on the notes and bonds it issues to fund the system's lending.

That would put Farm Credit's swap dealing well below the minimum annual level that the CFTC is looking at in order to increase oversight of large financial institutions in the multitrillion-dollar market for swaps, according to those familiar with the regulator's thinking.

Swaps are private "over-the-counter" agreements between parties to exchange one security or interest rate or physical commodity for another as a way to hedge or limit risk.

"I'm hearing the de minimis threshold will be raised to $8 billion annual gross notional of dealing activity, a significant increase from the proposed rule of $100 million and from previous drafts, where $3 billion has been the highest minimum," one source involved in the rule-making discussion told Reuters.


Any decision to exempt Farm Credit from swap dealer oversight will infuriate private banks, which compete with Farm Credit on farm lending.

For years, banks have complained bitterly about special advantages that Farm Credit has over them in lending to America's farmers and ranchers.

If the CFTC designated Farm Credit as a swap dealer, the ag lender would be subjected to higher capital requirements and other costs as well as to the higher level of oversight.

Bankers' arguments have zeroed in on whether regulators should let Farm Credit count customer swaps the same way as banks, which qualify for an exemption as "insured depository institutions" under the Dodd-Frank Act.

If Farm Credit is granted a similar exemption, none of the $3 billion in its customer swap exposure would qualify it as a swap dealer, according to lobbyists for both sides.

Farm Credit does not take deposits, as banks do. It raises funds by issuing debt securities, managing the yield curve and its interest-rate exposure in part through derivatives like swaps. F ar m Credit and its powerful political backers in Congress argue that although the lender is large, it poses no systemic risks to financial markets - it does not securitize its loans for resale, for example, and it collateralizes its loans against hard assets such as prime farm land.

For those reasons, they say that Farm Credit deserves a special status, given its role in farm and rural lending - an argument that drives private bankers to distraction.

"The FCS, ever the seeker of exemptions and special treatment, is trying yet again to gain favorable regulatory treatment," said Bert Ely, whose Farm Credit Watch newsletter posted a critique on March 28.

"Hopefully, the CFTC will slam the door shut on this shameless attempt by the FCS to cast itself as something it is not - a bank - in order to escape being regulated by the CFTC as a 'swap dealer,' as defined in the Dodd-Frank Act."

Banks say the implied government guarantee for Farm Credit - which was founded in 1916 as the first GSE -- makes for unfair competition, letting Farm Credit undercut banks on loan offers as well as making its cost of capital cheaper when it taps the world's capital markets. Farm Credit also enjoys lower tax rates than private banks.

Banking industry critics have been frustrated that Farm Credit has so far escaped oversight by the Federal Reserve or the U.S. Securities and Exchange Commission under Dodd-Frank, while banks are forced to comply with higher capital levels and absorb more costs of regulation. The lack of oversight for Farm Credit is the handiwork of the agricultural lender's powerful political allies in Congress, bankers say.

Farmers benefit in almost every Congressional district from Farm Credit lending, seeing the agricultural lender as a real counter to the power of private banks. So oversight of the system has been zealously guarded for decades by the U.S. House and Senate Agriculture Committees.

On the swap issues, the leaders of those committees made clear on March 29 in a letter to the CFTC that they backed an exemption for the Farm Credit System.

"Congress provided an exception for credit institutions that offer swaps in connection with loans from designation as swap dealers. This provision ensures that the flow of credit can continue between businesses and small to mid-size lenders and farm credit institutions," said the letter, signed jointly by Senator Debbie Stabenow, a Democrat from Michigan, and Representative Frank Lucas, a Republican from Oklahoma.

"It is going to be interesting to see how CFTC plays this," Ely told Reuters. "The legislative language they are trying to hang this on just doesn't wash. It may be: 'If you don't like it, sue us.' Then the question is, 'Who would go to the trouble?'" (Reporting by Christine Stebbins; Editing by Peter Bohan and Jan Paschal)