WASHINGTON -- To shore up supervision of the burgeoning derivatives market, the Comptroller of the Currency issued new guidelines Wednesday governing national banks' participation in the market.
Comptroller Eugene A. Ludwig, when he promised these guidelines on Sept. 27, said banks need a system to perform a coordinated evaluation of all the risks that derivatives pose.
"In derivatives. the slicing, dicing, and recombining of risk elements of products make it harder to see the risk," Mr. Ludwig said. "Banks need to be prepared to expect the unexpected. and these guidelines should help them do that."
Capitol Hill Appearance
Mr. Ludwig is scheduled to appear before the House Banking Committee today to discuss the risk posed to the banking system by derivatives.
Speaking at a Commodity Futures Trading Commission hearing on Wednesday. Treasury Under Secretary Frank N. Newman said that the OCC's new guidelines should not be misconstrued as a sign that the Clinton administration is alarmed by the growth of the derivatives market.
"It is important to emphasize that derivatives are both a potentially profitable activity for financial institutions acting as dealers and a useful risk management tool," he said.
The OCC's 26 pages of guidelines cover proper management of market and credit risk as well as operational and liquidity risk. The agency wants banks to have written policies and procedures to manage all these risks.
Much of what is in the guidelines is simply common sense, such as an admonition to bank boards and senior managements that they should understand and be involved in their institution's derivatives activities.
Doug Harris, the OCC's derivatives expert, said the provision likely to draw the most attention is one in which the OCC instructs banks to assess and document their customers' needs.
If derivatives are inappropriate for a certain customer the OCC wants the bank to advise against doing the deal. If the customer insists, then the bank is supposed to document its analysis as ammunition to fight any subsequent complaints from the customer.
"This is a clearly a new obligation we are imposing on derviatives dealers," Mr. Harris said.
But Townsend Walker, a senior vice president at Bank of America, said the provision is not a problem.
"That's the same kind of analysis a bank credit officer would perform on any transaction a customer would wish to undertake," he said. "This is no more than a prudent banker trying to know and understand his customer."
These products are financial instruments that derive their value from the performance of assets, interest or currency exchange rates, or indexes. Banks and their customers use derivatives to hedge risk, increase liquidity, and enhance yields.
These guidelines apply only to national banks. The other agencies may issue similar instructions in the future. And all the agencies are working on additional instructions that will cover the accounting issues that derivatives spur,
The interagency task force also will develop a data base to give the regulators a better grip on the industry's involvement in the derivatives market.
The OCC estimates that the notional amount of derivatives contracts held by all domestic banks is almost $11 trillion; the 25 largest institutions hold $10.5 billion of that total.
Banks are expected to follow the guidelines, but they are not legally required to, as with formal regulations.