Washington -- Comptroller of the Currency Eugene A. Ludwig announced Monday that he wants to bolster the supervision of derivatives products that banks both use and offer their customers.
Mr. Ludwig is forming an interagency task force to set accounting and capital standards for derivatives. He also wants the agencies to issue guidelines describing the systems that banks need to perform a coordinated evaluation of the various risk posed by derivatives.
"Banks need to put together systems that will allow them to uncover. . . new risk combinations -- in other words, to expect the unexpected," Mr. Ludwig said in a closed meeting of the Institute of International Bankers here. The Comptroller's office released to reporters a copy of the four-page speech.
Interim Guidelines Likely
While the task force does it work, the Comptroller's office is likely to issue its own interim guidelines this fall regarding the systems national banks need to tracks risks posed by derivatives, according to Doug Harris, Mr. Ludwig's senior policy advisor.
In addition to the Comptroller's office, the task force will include representatives from the Federal Reserve Board, the Federal Deposit Insurance Corp., the Office of Thrift Supervision, the Securities and Exchange Commission, and the Commodity Futures Trading Commission, Mr. Harris said.
The market for derivatives has exploded in recent years. The notational value of derivative products worldwide has ballooned to somewhere between $7 trillion and $15.5 trillion, Mr. Ludwig said.
Concerned About Newcomers
Banks use derivatives for a number of reasons, including hedging risk, increasing liquidity, and enhancing yields. Banks also package derivatives for use by their customers.
Regulators generally applaud the benefits of derivatives and are comfortable with the way most banks are using the product. But Mr. Ludwig said he is concerned that less-sophisticated banks will enter the market and lose money.
Currently in the United States, banks with more than $10 billion in asserts control 99% of the derivatives market. The derivatives market has not just grown in volume, it has gotten much more complex, Mr. Ludwig said.
The Inderdependency Factor
Banks must have systems in place to measure not only obvious risks, such as a change in interest rates, but to evaluate the effect that a change in one factor has on all others, he said.
"Derivatives' risks will depend upon a number of factors, including changes in market rates and prices, counterparty performance, market liquidity conditions, and the performance of payment systems," Mr. Ludwig said.
"The problem is that most of the techniques used by some of the newer market participants to evaluate derivatives' risks do not incorporate all of these factors; and more importantly, few if any institutions use evaluation techniques that formally recognize the interdependencies among those factors."
As an example, Mr. Ludwig said banks need to worry not just about a volatile rate environment but the effect changing rates have on the willingness of participants to enter a market.
This possible decrease in liquidity, he said, could increase the time needed to "unwind unfavorable transactions."
Banks systems need to be able to assess these related risks and how they affect one another, he said.
Mr. Ludwig also announced some staff changes yesterday. Konrad Alt, who came to the Comptrollers office in April as a special advisor to Mr. Ludwig, was named senior deputy comptroller for economic analysis and public affairs.
Frank Maguire, who for the last two years had held two positions at the agency, gives up his public and legislative affairs responsibilities to Mr. Alt and continues on as senior deputy comptroller for corporate activities and policy analysis.