Regulators are not gathering enough information about bank counterparties in derivatives contracts, according to the General Accounting Office.
"If any problem were to start spreading through the system and regulators wanted to check who the banks are exposed to, they wouldn't be able to get that through information they routinely collect," said Tom McCool, the GAO's associate director for financial institutions and markets.
The agency recommended that regulators "routinely collect and analyze industrywide information on individual counterparty credit exposures."
Apart from this caution, a 165-page report released last week by the GAO generally commended bank regulators for beefing up supervision of derivatives.
In particular, GAO noted that the agencies had adopted rules in September that require market risk to be incorporated into banks' capital standards. In addition, banks are now required to report separately the notional amounts of their over-the-counter and exchange-traded derivatives contracts. Finally, the GAO said, new risk-based examinations allow regulators to focus their supervision on the specific risks posed by derivatives.
The report updated one the congressional watchdog agency had done in 1994, calling for tighter regulatory control of derivatives transactions and prompting some lawmakers to introduce legislation designed to curb their use.
James L. Bothwell, the GAO's chief economist, warned banks in an interview Tuesday that they must understand exactly how derivatives work and what risks are involved.
"A lot has been done in the past two years to manage and control risks of derivatives," he said, "but the ultimate responsibility is still on the end-user to understand the product they are buying."
The GAO reviewed 20 key internal controls related to derivatives at 12 banks and thrifts. While the agency noted a number of areas where institutions' risk management needed improvement, most had appropriate controls in place.
For example, all but one had strong policies mandating that separate employees set hedging strategy, change trading limits, and execute trades. In addition, nine of the 12 institutions effectively set trading limits for specific market risks.
On the other hand, only half the institutions - all with at least $12 billion of assets and notional amounts of derivatives exceeding 25% of assets - had solid, management-approved written policies setting risk limits.