Fed's Phillips sees banks using swaps prudently.

WASHINGTON -- Despite recent swings in interest rates, stock prices, and exchange rates, banks are successfully managing their derivatives portfolios, Federal Reserve Board Governor Susan M. Phillips said Tuesday.

"From my perspective, what we are seeing, is that the risk management systems are working well," Ms. Phillips said.

She said these "market tests" demonstrate that banks are not treating derivatives lightly, as some in Congress fear. Rather, banks are successfully managing their swaps to avoid future loses.

Ms. Phillips said she can't imagine risk managers trying to discover if their systems work in a much more volatile and difficult market than the one they have encountered in 1994.

"We have seen rough markets this year," she said. "There is no doubt about it."

Outside monitors of the derivatives industry mostly supported Ms. Phillips assessment.

"I think that is to a degree fair," said Karen D. Shaw, president of the Institute for Strategy Development. "But I don't think we want to [field] test the ability of banks to lose their capital."

Ms. Shaw said banks did adapt well to the spring interest rate hikes. But, she said, it is too early to judge how they handled the exchange rate and stock price fluctuations of this summer.

"It won't be until the third quarter when we can find out the effect," she said.

Ms. Shaw said that although she is waiting for more evidence before rendering a final judgment, she does agree that banks have appeared to do well and that their swaps activities do not appear to threaten the industry.

"That is an important public policy point because if people take big, dumb bets, they should lose," she said. But, banks shouldn't gamble with government-insured money, she said.

Gay H. Evans, chairwoman of the International Swaps and Derivatives Association and managing director of Bankers Trust International in London, said banks do know what they are doing. "I agree," she said of Ms. Phillips' comments. "I think it is something that people haven't realized."

Ms. Evans said that despite enduring the most volatile market in years, bankers have not lost any money in their derivatives transactions. She said bankers possess a self-interest in maintaining strong internal controls because-without them, institutions are less likely to make profits. Ms. Phillips said the market volatility has given regulators a chance to see the banks' internal controls in operation. This will help them formulate future policies, she said. She also said that banks should not interpret her comments to mean that the Fed is backing away from this issue. She said the evolving nature of the derivatives market requires constant regulatory attention. Finally, Ms. Phillips cautioned that the regulators always need to look for that potential problem on the horizon.

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