One of the country's top banking regulators warned that banks will have to step up their internal controls in the wake of the Daiwa scandal.

But Robert McCormick, the deputy superintendent in charge of supervising foreign banks for the New York State Banking Department, added that it is unlikely new state or federal regulations will be put into effect to curb the activities of rogue traders.

"We prefer to take a more balanced approach," Mr. McCormick said. "We'll all be better off without having laws that go into effect and can't be changed."

Addressing auditing staff members from foreign banks at a meeting of the Association of International Bank Auditors last week, Mr. McCormick emphasized that foreign banks will have to do better at complying with existing laws in order to avoid frauds like the one that cost Daiwa Bank $1.1 billion.

"Internal auditors must be able to function as an early warning system for management," said Hal Labrett, chairman of the bank auditors association.

Mr. McCormick noted that many banks have been lax in enforcing a federal rule that requires all bank employees to take two weeks of vacation annually. Had that regulation been enforced at Daiwa, he said, the bank would have had a chance to detect a senior trader's fraud because another employee filling in for him might have discovered his falsified entries.

"Some Asian banks seem to think that going on vacation means coming into work without a necktie," Mr. McCormick said.

He added that vacation meant "not only off-premises but off-line as well, and that means no trading from home."

Mr. McCormick's remarks came as part of what he termed a "forensic" review of the Daiwa fraud. The Japanese bank was ordered last year to give up its U.S. operations. And last month, it agreed to pay $340 million in fines for covering up and failing to report the losses to U.S. authorities.

Both Mr. McCormick and Donald Vangel, senior vice president at the Federal Reserve Bank of New York, emphasized that the primary responsibility for detecting improper operations lay with the banks themselves.

"It should be fairly obvious that banks live by the strength of their internal controls and risk management," Mr. Vangel noted. He also warned that banks should be careful not to jeopardize internal controls in "their haste to meet competition" or by "aggressive cost containment."

Both regulators called upon home country supervisors and foreign bank senior executives to take a more active role in monitoring operations at their U.S. offices.

The two regulators also stressed that internal auditing staffs need more independence from local managements in order to function effectively.

"Local audit functions should report directly to the head office and not to branch managers," Mr. Vangel emphasized. "Unless the control function has the organizational clout to challenge all businesses, I would suggest that what we have is the illusion of control rather than control itself."

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