Shawmut National Corp.'s chief investment and funding officer, Thomas D. Wren, is used to presenting complex concepts in numerical terms.
Lately, though, he's been grappling with a frustrating task: assigning a number to the bank's reputation with its customers.
The task stems from the introduction last year of a family of nine mutual funds marketed by the New England bank. If any of them are unsuccessful, it could severely damage Shawmut's reputation with its customers, Mr. Wren said.
"Reputation risk is a new form of risk that banks are confronted with now," he said. "What happens if something goes wrong? That's one we're having trouble with. How do you actually put a dollar amount on it?"
It is an important question because Shawmut is in the midst of a process Mr. Wren call the "aggregation project." The goal is to give the board of directors a handle on the highly complex world of risk management, and reputation is just one of a list of risks it is his job to review.
The idea is the reduce the risks from Shawmut's business lines to a simple set of figures that can be presented to the bank's board in an easily digestible report at year's end.
Mr. Wren noted that since a bank's reputation is intangible, it has proved impossible thus far to create policies to deal with any problems that might arise.
Compared with reputation risk, he said, it is relatively easy to devise a strategy to combat that risks associated with, say, the options market.
To help quantify credit, interest rate, liquidity, operational, and reputation risk, Mr. Wren said the heads of Shawmut's major committees report to him regularly. He in turn reports to the bank's asset and liability management committee, which reports to the board.
The goal of the aggregation project is not to supplant the bank's various committee's, Mr. Wren noted, but to supplement them and help quantity the bank's risks so that overarching strategies can be enacted to help control them.
"Eventually it may replace the separate committee," he said. "But that's not our goal. This wouldn't replace our interest rate risk and liquidity risk guidelines, for example. It's just a layer on top. But you don't want to make it more complicated."
Mr. Wren said Shawmut already has established guidelines to handle most kinds of risk.
"Our credit risk committee creates policy on portfolio risk," he said. "With this project we're looking at how we can handle the loan portfolio on a macro basis. We'll try to quantify credit risk using a number."
Mr. Wren said his ultimate goal is to be able to go to Shawmut's board and break down each department's risks in its simplest terms.
He said he'd like to give the board members a report that states in essence that the bank's credit risk, for example, is a particular number on a scale of one to 10, with 10 being the highest amount of risk.
In this way, he pointed out, upper management could then plan a strategy to reduce the risk.
"The actual number doesn't mean that much, he said, likening it to the notional amount of a derivatives portfolio, which is not the actual amount of a bank's derivatives holdings but a representation of its position.
"The change over time is more important," he said. "The number might not translate directly to a change in position."
Shawmut, with assets of more than $27 billion, is relatively conservative when it comes to hedging its portfolio, said Mr. Wren.
While the bank does use derivatives, they are mostly interest rate instruments used to hedge its balance sheet.
"Everything we do with derivatives is for hedging," said Mr. Wren. "We use them to hedge rising interest rates."
According to Shawmut's 1993 annual report, the bank uses futures contracts, interest rate swaps, options, and caps for asset-liability management. It also uses some foreign exchange instruments.
The annual report notes that Shawmut had $2.4 billion in notional balances of interest rate caps at yearend 1993 and nearly $2 billion in interest rate swaps.
Futures contracts totaled $2.5 billion, and options contracts $786 million. Foreign exchange commitments amounted to more than $11 billion.
Mr. Wren said Shawmut started using some hedges in the second quarter of 1993, well before interest rates started turning against banks.
"We looked pretty silly initially, but they have helped a lot this year," he said. "It's best to do them when it's least expensive."
Shawmut now uses derivatives and the cash markets interchangeably, he said, because it is cheaper to go into the cash markets now.
"We're pretty conservative," he said. "If you have a rate risk view, you should try to run a cash instrument."
He also noted that while Shawmut should by no means be considered a trading bank, it does do some swaps and options trading for customers at their request.
"If we had customer demand for it we'd go into it more, but we don't," he said.
Shawmut's annual report states that the bank's trading profits for 1993 fell slightly to $6.4 million from $6.6 million the previous year.
Foreign exchange trading was off sharply, falling to $2.9 million last year from $9.3 million in 1992. The bank attributed the falloff to "unfavorable interest rate differentials."
Mr. Wren noted that all the derivatives deals done for customers use plain-vanilla instruments. Shawmut does not go in for the more exotic products, he said.
The plain-vanilla instruments are "easier to measure and model. It's much easier to get an option price on a plain-vanilla instrument than on an exotic," he said.
He also said he does not expect ever to be able to quantify all of the risk facing Shawmut once the aggregation project is up and running. Some risks, he said, just cannot be measured.
"We'll shoot for getting 75% to 80% of the risk in our first pass," he shrugged. "There's always going to be some judgment in this process."
