Use common sense with derivatives, Ludwig tells banks.

WASHINGTON -- Eugene Ludwig, the comptroller of the currency, told a group of bankers yesterday not to rely too heavily on sophisticated mathematical models when making investment decisions involving derivative instruments.

"The most sophisticated risk management models have their limits," Ludwig said in a speech before the Savings & Community Bankers of America in Lake Buena Vista, Fla.

"There is an inherent degree of subjectivity in the quantification of risk -- it has been and remains today an art as well as a science," Ludwig said. "For that reason, the essence of sound risk management will always be good judgment and experience."

Ludwig urged bankers to use common sense when investing in the often complex instruments. "If a security looks too good to be true, it probably is. Most likely, you or your staff do not understand all of the risk elements," Ludwig said.

He also cautioned that bankers should shop for the securities in their portfolios rather than have the securities marketed to them.

"An institution that buys its portfolio is following an investment strategy that outlines what the portfolio is trying to accomplish -- usually aa as. set-liability management objective," he said.

Last year, the comptroller's office issued guidelines for national banks when investing in derivatives that covered all aspects of risk management, including senior management and board oversight, market risk management, credit risk management, and liquidity risk management.

In July, the comptroller's office said some types of structured notes, because of the risks' involved and the difficulty in assessing those risks, are inappropriate investments for banks. The office said in the July advisory. letter that determining whether a particular instrument is appropriate depends on the bank's ability to understand and control that instrument's risk.

--Joanne Morrison

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