BankAmerica's Joe Bauman feels derivatives will not just be the domain of the big players, but will be found in every bank's portfolio.
It doesn't take much to get Joseph Bauman to sing the praises of derivatives.
Just~ mention a recent headline about a company reporting derivation losses and the exective, who recently moved from Citicorp to a newly created global risk management job at BankAmerica Corp., politely points out lesser-known examples of the good that financial engineering has done.
In a recent interview, Mr. Bauman preached the gospel that derivatives help companies do what the cash markets cannot. For commercial banks, he says the educational use of derivatives can be an effective tool in managing interest rate risks and safety adding to the bottom line.
He should know. Citicorp, where he was head of business development in the global derivatives group, is one of the largest users of derivatives among U.S. commercial banks. Globally, it is one of the most aggressive dealer in the exortic products.
Mr. Bauman declined to discuss his bank's activities in the derivatives market. However, in his capacity as chairman of the International Swap Dealers Association - a post he will relinguish in order to take his new job at BankAmerica - Mr. Bauman agreed to discuss the state of derivatives use; the danger of overregulation of the budding market; and the role he sees banks playing as users in the exploding market.
Q.: Big banks are users of derivatives now, but regulators say thay only about 5% of all chartered banks report some usage. Do you see that growing?
BAUMAN: Yes. I think that derivatives will become a normal part of the portfolio of products that every institution will want to use to manage risks. Think of how far the business has come already.
Q.: But what will it take to broaden that universe of bank endusers?
BAUMAN: Derivatives have been developed mostly as a tool for larger firms, and most of that has to do with the fixed cost of delivery. Larger banks tend to have portfolios that lend themselves to the use of derivatives.
Over time, we have seen the average cost of providing the product come down. Anothe factor is that today there are more applications [for derivatives] which meet the requirements of smaller institutions. You are going to see more products being developed that are of a higher utility to more banks.
Q.: Even if they don't use derivatives themselves, how important will it be for banks to be able to act as intermediaries if their customers - such as corporations - need derivatives?
BAUMAN: Because credit will remain a characteristic of the over-the-counter derivatives market, there is always going to be a role played b~ financial institutions that is a credit-extender to its proprietary customer base.
Q.: Does that mean that smaller banks risk losing customers to the bigger players if they chose not to get involved in derivatives for their clients?
BAUMAN: I don't believe they do because of the need to look at these products as an extension of credit. They need to be able to serve the client in a classic banker fashion, which will keep those relationships with the local institution.
Q.: As you are aware, derivatives has become a kind of scarelet letter to Wall Street and investors these days. Will the new push toward futher disclosure help companies like Banc One Corp?
BAUMAN: Well I am not a stock analyst so I can't comment on any particular company, but I think Banc One did the right thing by taking its case to the public to show how and why they are using the instruments.
I think its part of the educational process. It can only help people to understand what it all means. Derivatives can be like walking into an advancecd physics class and seeing the formulas but not having the context in which to understand why the formulas are there.
Q.: One of the concerns is that end-users may be crossing a fine line between risk management and speculating. What are the red flags?
BAUMAN: The red flag has to be a more broader, more sophisticated understanding of the affects of changes in the deconomics environment in general, such as interest rates, currencies rates, commodity prices orf whatever, on the net income of the firm. And derivatives may only make up only one component of that and it would be a mistake to pull out in isolation.
.: A good deal of ISDA's time has been spent on legislative and regulatory issues around the world. Is the objectives to have unifrom standards or just ones that are clear?
BAUMAN: What we want to do is have everybody working off the same definitions, the same agreed upon intent of how the activities are meant to be represented.
Q.: In this country, what is the greatest risk to the derivatives markets from legislation that is under draft?
BAUMAN: There is a risk that legislation would increase the cost of doing business. But the greatest risk is that Congress will take discretion away from, you might say, the marketplace, but more appropriately the regulators and force a certain path of activity that limits their ability to respond flexibly.
Q.: But hoe do you write guidelines for a market when you don't know what it will be in 12 months or 12 years?
BAUMAN: You empower the regulators to do their jobs which is to monitor and take appropriate steps as in other [U.S.] markets.
