Regulators may be concerned about the risks related to foreign exchange trading at large banks, but analysts said they believe small and medium- size institutions are more likely to get into trouble.

"The biggest risk would appear to be smaller banks that trade in the foreign exchange markets without the sophisticated control systems of a Citicorp, Chase or a Morgan," said Raphael Soifer, a banking analyst with Brown Brothers Harriman.

Lawrence Cohn, a banking analyst with PaineWebber Inc., agreed. "I have no concern about big money-centers banks, because they're acutely aware of the risks," he said. "But it is possible that there are secondary regional players whose controls may not be as good."

The analysts were responding to a warning last week by the head of the New York Federal Reserve Bank. Speaking at a news conference in London, New York Fed President William J. McDonough said that banks face "huge potential exposures" from foreign exchange trading.

Mr. McDonough stressed that current settlement practices are woefully inadequate and leave banks exposed to large potential losses for several days.

Last Wednesday, the committee on payment and settlement systems of the Group of 10 central banks, issued a report on settlement risk that underscored Mr. McDonough's concerns.

The report did not call for radical new settlement procedures. Instead, it recommended that banks move to reduce their risks individually and collectively by improving back office processing, correspondent banking arrangements, netting capability and risk management controls.

"Well designed multicurrency settlement mechanisms and netting arrangements could greatly enhance the ability of individual banks to reduce their foreign exchange settlement risk," the G-10 committee suggested.

Even if improving current settlement procedures will be expensive, the report said, "these costs pale in comparison with the potential cost of continuing business as usual."

The report, based on a survey of 80 banks around the world, added that the committee plans to monitor how banks implement recommended foreign exchange settlement guidelines over the next two years.

Mr. Cohn of PaineWebber speculated that the warnings over settlement risk were directed mainly at Japanese and southern European banks. But he added that it was also important that U.S. regionals take a close look at their own settlement systems.

"The flows are huge, even for second-tier players," he said. "Even if the revenue streams are not that important, the amounts at risk are enormous, so it is important to have strong controls."

U.S. money-center banks rank among the top players in worldwide foreign exchange. Citicorp ranks as the largest trading bank with more than $1 billion in foreign exchange revenues last year, according to SNL Securities.

BankAmerica Corp. was the next largest with $303 million in revenues, followed by Chemical Banking Corp. with $280 million and Chase Manhattan Corp. with $241 million.

Although foreign exchange continues to be dominated by large banks, regional players, including Mellon Bank Corp., First Union Corp., NationsBank Corp. and Harris Bank and Trust all have sizable foreign exchange operations.

U.S. banks have avoided major losses from foreign exchange trading, but were forced to reduce trading in the early 1990s after their credit ratings were severely downgraded due to industrywide asset problems. The largest single recent trading loss at a U.S. bank came last December when Chemical Bank lost more than $70 million after one of its traders bought unauthorized contracts against the Mexican peso.

Although banks already use a variety of controls and netting arrangements to reduce foreign exchange risk, regulators' concerns about large exposures have grown as worldwide trading volume has climbed sharply over the last decade. As of April 1995, when the Fed and other leading central banks ran the last international survey, global foreign exchange trading stood at $1.23 trillion a day.

Analysts however emphasized that although risk can be reduced, it cannot be eradicated completely.

"There's no panacea for it," Mr. Soifer said. "You can limit risk, you can control it, but you can't eliminate it."

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