Banks' Monitoring Of Derivatives Risk Gets Qualified Praise

Banks are getting better at monitoring derivatives risk, a top regulator acknowledged Thursday - but he added that management oversight is still inadequate.

In a speech to the Bankers Roundtable Lawyers Council in Washington, Douglas E. Harris, a senior deputy comptroller, said inadequate oversight by senior managers and boards of directors was the most important of three deficiencies that "deserve special attention."

The other two were: measuring and controlling risk, and establishing risk limits; and relying on independent risk management and support limits.

In the wake of the derivatives-driven debacles at Barings PLC, Orange County, and a host of others, the Comptroller's office is focusing its attention on ensuring banks have sufficient risk monitoring systems and experts.

Mr. Harris said while derivatives are unusual securities, the fundamental risks are familiar ones: credit, market, and operations risk. Nevertheless, his agency has seen deficiencies in controlling these risks in bank examinations for the past year and a half.

"Other procedures and controls don't necessarily fall into place unless (management oversight) is cautiously and prudently performed," said Mr. Harris.

Following the Barings failure, Mr. Harris asked the largest national banks to initiate a self-assessment of their vulnerability to Barings-type problems.

The review corroborated the agency's concern about management oversight. Mr. Harris said a couple of institutions admitted that management had to make a better effort to get market information and rumors off the trading floor and up to the offices of senior managers.

None of the banks found any significant deficiencies in their trading policies, controls, or operations, said Mr. Harris, although some are changing their control systems to strengthen risk management processes.

Mr. Harris noted some general improvements, including the establishment of independent position valuations, development of better reporting of exposures during the market day, and reviewing of credit risks associated with trading on various futures and options exchanges.

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