MIAMI - The money-center banks of the world were not the only ones fidgeting after last month's collapse of the British merchant bank Barings PLC.
Small community banks also use derivatives - the financial instrument that Barings' Singapore trader used in bankrupting the company - and they need to draw the same lessons as others from last month's fiasco, according to industry experts.
"Smaller banks have been involved in these things just as much as the big ones," said Stephen D. Smith, a visiting scholar at the Federal Reserve Bank of Atlanta. "In the sixth district (the Southeast), we have seen small banks use them to their limits."
The recent bad press on derivatives probably won't hinder their use by the larger banks, which rely on them primarily as a cheap and efficient method of hedging their sizable investments in numerous currencies, Mr. Smith said.
But small banks that might use derivatives to offset the risks associated with a long-term fixed-rate mortgage, for example, may need to think hard about getting into derivatives or expanding their use of them, experts said.
First and foremost, bankers need to fully understand derivatives, and to do that costs money, they said.
"Small bankers will have to be aware of the costs of educating themselves if they are going to go in to these markets," Mr. Smith said. "There's a tradeoff there that they have to consider. I think there is the possibility even at the small-bank level to use them constructively, but not to the same degree as the big banks. The costs are too high."
A third-party investment adviser should be considered as a relatively inexpensive means of understanding these investments, Mr. Smith said. These contract services may make more sense for small banks than retraining staff or hiring new people, he said.
Edward D. Kane, a professor of banking and finance at Boston College, says the Barings episode is healthy for the industry.
"If you never have a close call, you can get in to bad habits," Mr. Kane said. "In this respect, it's (the Barings episode) a wake-up call. This should make regulators as well as the supervisors within banks extra vigilant."