New reserve requirements for market risk have aroused complaints from big trading banks, but according to a new study, the rules could have been much tougher.
Standard & Poor's Corp., the credit rating agency, found that the reserves being required by the Federal Reserve Board wouldn't cover the kinds of losses banks have experienced on trading in the past.
The requirements are due to take effect in January 1998. Banks are preparing for the rule by assessing how their portfolios would respond to various market changes.
The rules were established in response to trading debacles at Barings PLC, Bankers Trust New York Corp. Daiwa Bank Ltd., and others that showed banks are vulnerable to changes in distant markets.
Prominent trading banks represented by the International Swaps and Derivatives Association have complained to regulators that the requirements impose excessive costs on banks that manage risk well and fail to punish those that don't.
But Tanya Azarchs, a bank analyst at Standard & Poor's, found that the large trading banks will have very little to complain about.
Such banks as Citicorp and J.P. Morgan & Co. will have to reserve so little capital compared to the size of their trading portfolios that it raises questions as to how well protected they will be in case of a crisis, Ms. Azarchs said.
"Banks are going to have to put up $150 million to $500 million to fulfill the capital requirement, but they can make or lose much more than that quickly when something they don't expect happens."
According to S&P, Citicorp would have had to set aside $545 million to protect its 1995 trading portfolio of $21.75 billion. That's the most of any bank, even though other banks had significantly larger trading portfolios.
That's because the reserve depends on banks' formulas and methods for calculating risk and on the type of trading, rather than the amount of money at stake.
For example, J.P. Morgan & Co. would have had to set aside only $251 million to support its trading portfolio of $38.4 billion. Bankers Trust New York Corp. would have had a capital requirement of $285 million to cover a $30.6 billion trading portfolio.
But even once losses were estimated and reserves in place, Ms. Azarchs said, banks would still be exposed to much greater, albeit unquantifiable, risks.
Employee fraud, legal risk, and reputation risk can all cost banks much more than if interest rates spiked up somewhere. The greatest losses in recent years have come mainly in areas where the most advanced risk management models cannot go, Ms. Azarchs said.
She pointed out that a single employee destroyed Barings by doing unauthorized trades, and that Bankers Trust lost about $200 million on legal settlements.
Ms. Azarchs said banks' fears of higher costs may prove to be unfounded, because the rules waive most of the expenses the banks pay to cover credit risks.
"In many cases the credit risk capital requirement is as much or more than the market risk requirement," she said. "So this might provide relief for some."
