Federal Reserve Governor John P. LaWare had some advice last week for senior managers at banks that buy and sell derivatives.
Mr. LaWare described what steps he believes are essential for banks involved with the complex financial contracts.
Management must understand the instruments being used and should be kept informed of market and portfolio shifts, he said. Stop-loss disciplines that can trigger the close-out of a position should be in place.
Limits also must be set on how much money the bank can lose in each risk category, he explained. Authority to make exceptions to those limits should rest with senior officials who are not responsible for trading operation profits, Mr. LaWare said.
Other musts include:
* Adequate assessments of counterparty credit risks.
* Market models that let management perform a stress-test of the bank's position.
* Experienced managers who know how to trade in both volatile and stable markets.
"I am convinced that with full disclosure by banks of their derivatives activities and exposure, trained examiners will be able... to protect against disastrous loss that would threaten depositors and shareholders," Mr. LaWare said.
Mr. LaWare said he sees no need for Congress to regulate the instruments, noting that the big losses publicized recently had happened to sophisticated market players.