WASHINGTON -- The House Banking Committee has scheduled a hearing Oct. 28 to examine the risks associated with the banking industry's involvement in derivatives.

Committee Chairman Henry B. Gonzalez, D-Tex., who has asked top federal regulatory officials to testify, said the examination is needed because the banking industry's total credit exposure from derivatives holdings ranges from about $100 billion to $200 billion.

"The Banking Committee and the regulatory agencies must unwind this mystery called the derivatives market because the ultimate bank insurers -- the American taxpayers -- deserve to know what they are underwriting," Gonzalez said in a written statement that was recently released.

Gonzalez said he does not necessarily want to restrict banks from engaging in derivatives, which they can use to help minimize risk and increase profitability.

However, he said, "what is good for one bank may not be good for all of them." He noted that when the banking industry jumped into loans for less-developed countries, for leveraged buyouts, and for speculative real estate, many banks failed.

"I do not want to see that same shortsightedness rear its ugly head under the guise of derivatives," Gonzalez said in the statement.

"This may be a market that some can use to great advantage -- but great profits also entail great risks," Gonzalez said. "We need to understand and control these risks."

In separate letters to bank regulators -- including Susan M. Phillips, a Federal Reserve Board governor; Eugene A. Ludwig, the comptroller of the currency; Jonathan Fiechter, acting director of the Office of Thrift Supervision; and Andrew Hove, acting chairman of the Federal Deposit Insurance Corp. -- Gonzalez asked four major questions.

He said that committee members want to know: can U.S. bank regulators adequately identify and address the risks associated with derivatives; are banks using derivatives to engage in "casino-like gambling" activities; are banks being required to set aside enough capital to cover potential losses; and would the deposit insurance fund be better protected by moving derivatives out of banks and into subsidiaries?

Gonzalez also asked the bank regulators to describe their agencies' strategies for monitoring and supervising the involvement of banks in derivatives.

He asked them what catastrophes in the markets could cause a derivatives-related bank failure and whether banks are required to formulate contingency plans for such catastrophes. He asked whether the agencies can define and identify when firms are engaging in derivatives activities for speculative reasons. The agencies should comment on the feasibility of levying a tax on derivatives transactions done for speculative purposes, he said.

Gonzalez said most derivatives activities are concentrated among a handful of large money center bank holding companies and asked to what extent this is good or bad for the banking industry. He asked the agencies to provide financial information on the top 10 bank holding companies that are derivatives dealers. He said committee members want to know whether banks should be required to establish separately capitalized holding companies to engage in derivatives activities.

Gonzalez asked Arthur Levitt, chairman of the Securities and Exchange Commission, to testify at the hearing. In a letter to Levitt, Gonzalez asked him to describe the extent to which the SEC regulates the derivatives activities of banks and bank holding companies. He also asked whether the financial reporting by banks is adequate to reflect derivatives risks and whether the SEC requires bank holding companies to disclose information on off-balance sheet derivatives activities.

In a letter to Sheila Bair, acting chairwoman of the Commodity Futures Trading Commission, Gonzalez asked for a summary of the findings and recommendations of the commission's soon-to-be-issued report on derivatives. He asked Bair to describe the extent to which the commission cooperates with other agencies in regulating derivatives. He also asked whether there are competency training and testing requirements for financial officials that regulate and that deal with derivative products.

Gonzalez asked Clifford Griep, executive managing director of Standard & Poor's rating group, to testify about whether the increased derivatives activities of financial institutions have affected their financial condition or credit ratings. He said Standard & Poor's has decided not to develop new ratings to cover hybrid derivatives products and asked Griep to discuss the difficulties in placing a value on such products. Gonzalez asked how the marking to market of a bank's derivatives product would affect its financial condition.

Gonzalez asked Charles R. Taylor, executive director of the Group of 30, to testify about what federal regulators and Congress should do if financial institutions and investors involved in derivatives fail to follow the recommendations of the group's recent report on derivatives. The group, whose members are international financial experts, issued a report on derivatives earlier this year that made a series of recommendations aimed at reducing the risks associated with such products.

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