Understand Derivatives or Stay Out, Directors Warned

WASHINGTON - If bank executives and board members don't understand derivatives, they have no business letting their institutions deal in them, New York Fed President William J. McDonough said Thursday.

"I give a very bad time to boards of directors and managers if I get the response that 'the stuff is too complicated for us to understand,'" Mr. McDonough said.

Speaking at a conference on foreign banks sponsored by the Office of the Comptroller of the Currency, Mr. McDonough said most banks with derivatives problems are those with top executives who do not understand underlings pushing the products.

It's not that bank managers are stupid, he said. "Ninety-nine times out of 100, the problem is not with the person who is hearing it but that the younger person typically explaining the product cannot explain it in understandable English, Spanish, Portuguese, German, whatever. And that is usually because the young person really doesn't understand the risks of the product."

He concluded, "There is much to be gained by the intellectual humility of an older person like me saying, 'If you can't explain it to me, we're not going to do it.'"

Also at the conference, Comptroller Eugene A. Ludwig announced that within days his office, the Federal Reserve Board, and the Federal Deposit Insurance Corp. would publish a proposal to incorporate into capital standards banks' risk from trading derivatives, currency, equities, debt, and commodities.

The proposals are based on an April agreement by the Basel Committee on Banking Supervision to let banks use their own models to project the risks they face from trading activities.