In a hearing today, the House Banking Committee will quiz regulators and bankers about risk assessment - a trendy topic as everyone tries to get a handle on the risks posed by new lines of business and by portfolios laden with derivatives, emerging markets securities, and foreign currency holdings.
Among the witnesses will be Lewis W. "Woody" Teel, executive vice president in charge of trading risk management at Bank of America.
Mr. Teel got his start in risk assessment in 1974, when Bankhaus Herstatt of Cologne, Germany, failed because of foreign-exchange trading losses, and big banks worldwide realized they needed to do something to control their exposure to such collapses.
Fresh out of law school, Mr. Teel helped set up Bank of America's first trading risk control systems. He later became the bank's corporate treasurer, then moved on to a series of top trading jobs and a stint as chief financial officer of the bank's wholesale and international operations. In 1992 the bank decided to consolidate and strengthen its trading risk management, and put Mr. Teel in charge.
Bank of America is fifth among U.S. banks in trading revenue, and has been a leader in developing "value-at-risk" computer models that measure how much the bank's trading portfolios could drop in value if the markets move the wrong way.
In an interview with American Banker reporter Justin Fox at Bank of America's San Francisco headquarters last week, Mr. Teel talked about risk and how he tries to manage it.
How do you go about managing your trading risk?
TEEL: There are two parts to it.
The first is a quantitative thing: We measure risk.
The second is a social thing: We try to create an environment whereby all of the traders know that everything they do is being watched and they don't have any motivation to take the first bad step.
We try to keep our risk measurement systems at the state of the art. We have been working on implementing value-at-risk systems quite a lot longer than the period during which this phrase has become popular. We still don't have it implemented fully across the company, and I don't know of anybody who does. But we've got it implemented for 85%-plus of our trading volume, and 95% of the trading risk.
On the other side, in creating a culture where the trader really never thinks in terms of taking that first step down the wrong road, you've got to recognize that trading is extremely fast-paced. There are good reasons for limits to be exceeded all the time, and you've got to have a recognition of this along with a process of assessing which are the good excesses and which are the bad excesses.
Are you confident that the systems you have in place will prevent a billion-dollar loss or a Barings-like collapse?
TEEL: There are a variety of ways that you can lose money.
There's a category of billion-dollar losses that occurred as a result of bets taken that were fully understood by traders and management. Then there are losses where the traders knew exactly what the positions were, but management might not have.
Then there are some losses where the traders didn't really understand the positions they were taking. And there are the losses like Barings where the traders went rogue and just outright defrauded the company.
We take trading positions all around the world. We understand and agree to take those positions, and things can happen in markets. The fact that we measure risk on a two-standard-deviation basis and say that our risk of loss is $30 million on a given day doesn't mean that we won't get a 10- standard-deviation event. We've seen them.
What I'm highly confident of is that we will not have a major loss that comes from either a trader doing something that we didn't know about, or a risk position that we didn't understand the magnitude of.
I am overwhelmingly highly confident that nothing can happen that can imperil this company. There isn't market capacity in the world to do that. The risk limits that markets and the other players in the world are willing to give us wouldn't allow positions to be created which could affect our $20 billion of capital and $5 billion of pretax earnings. It isn't going to happen.
Trading's important for us, but it's still 6% of this company's revenue. We don't depend on it like some of the other players in the market.
Can you and your staff really understand everything that your derivatives traders are doing?
TEEL: We're watching what they do through computers and reporting systems - and the odd visit, where we'll kick over rocks, sit with traders for a few days, and watch them.
I do that, too. I'll go into rooms and just have nothing else on my agenda but to sit and watch the traders. Kind of pull up a chair and watch. Drink coffee and act like I'm bored. But try to be sure I understand what they're trying to do.
How big a factor are over-the-counter derivatives in Bank of America's market risk picture?
TEEL: Very small. When you look at what the traders really do, when they get a deal with a counterparty they tend to hedge it almost immediately. The way they think is that they're after the spread on the trade; they're not after using a derivative trade with a customer to create a market risk position and then wait for markets to prove that they're right.
The derivatives part of the market risk pie is very, very low on any given day. Securities' is high, especially emerging markets securities, where you've got the risk of the big moves. You know, Yeltsin goes on a bender, and Russian debt moves 30%.
U.S. interest rates can move, too. Listen, I was the treasurer of this company for a period of time, and that period of time included March of '80, when U.S. interest rates moved 10% in a month. If you've lived through that, you have a very interesting appreciation of risk.