WASHINGTON - Banks have significantly reduced their exposure to highly leveraged institutions since the near-collapse of the hedge fund Long Term Capital Management 17 months ago, according to a report released Tuesday by the Basel Committee on Banking Supervision.
The report, based on an informal survey by banking supervisors in the Group of 10 leading industrialized countries, also urged banks and their regulators to "lock in and further strengthen improvements" in the way risks associated with lending to highly leveraged institutions are measured and managed.
Federal Reserve Bank of New York President William J. McDonough, who also is chairman of the Basel committee, predicted in a release accompanying the report that highly leveraged borrowers will "continue to expand their activities and remain significant players in the financial markets."
The report, which succeeds an analytical paper and sound-practices report released by the committee in January 1999, also concluded that banks have improved due diligence, collateral management, and risk measurement.
But it said the degree of improvement varies from country to country and institution to institution. For instance, regulators in some countries have integrated a review of banks' risk management policies and practices into their on-site examinations, according to the report.
"Although there has been progress in the past year, there remain important areas where further work is needed, both at the industry level and at individual firms," according to a statement by Jan Brockmeijer, chairman of the committee's working group on highly leveraged institutions. "This includes several technical areas such as potential future exposure measurement, collateral management techniques, and stress testing."
The committee recommended that banks and industry associations make a "collective effort" to demand more transparency from highly leveraged institutions so that risks can be better measured. These demands should include explicit assurances that proprietary information about hedge funds' trading techniques will not be available to the banks' own trading units, it said.
Banks should also strive to improve the methods they use to measure their exposure to highly leveraged institutions and adopt stress tests for those portfolios.
The committee urged regulators to continue demanding sufficient data on banks' exposure to highly leveraged institutions and to consider sharing such information with their counterparts in other countries.