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• W38858796 abstract "Almost two years ago, E. Gerald Corrigan, then head of the New York Federal Reserve Bank, took the occasion of a speech before the New York State Bankers Association to officially raise his eyebrows regarding the burgeoning involvement of commercial banks in off-balance-sheet instruments, notably interest-rate swaps. Corrigan's concern was basically this: Do bank CEOs know what their whiz kids are doing? helped set in motion a flood of public and private analyses regarding At ABA's recent Annual Convention, Federal Reserve Board Chairman Alan Greenspan took the opportunity to generally caution banks about derivatives-and to specifically ask whether the computer models the whiz kids use were all they appeared to be: It is especially important that senior managers of the system continuously acquaint themselves with the intricacies of the underlying assumptions that these models require in order to make certain that the decisions, where crucial, are not implicitly being made by skillful, but market-inexperienced, mathematicians. WHAT'S BEING DEBATED. Since Corrigan's speech, bankers have watched a parade of headlines go by regarding derivatives. Of late, the news has been dominated by steps taken by the Office of the Comptroller of the Currency and hearings held by the House Banking Committee. But virtually every group or agency with a role in financial oversight--in the U.S. and globally--has had something to say. Behind the headlines is the concern that derivatives hold the potential of being the next financial crisis. These doomsdayish worries are capsulized in a single phrase: systemic risk. In a late 1992 study by the Bank for International Settlements, the phrase was defined as follows: risk that a disruption (at a firm, in a market segment, to a settlement system, etc.) causes widespread difficulties at other firms, in other market segments or in the financial system. Much of the current debate over derivatives concerns a subset of those instruments that are other transactions. Specifically, interestrate and currency forwards; options; swaps; caps, floors, and collars; and their combinations and variations as well as related instruments. As noted in a section of an early 1993 report by regulatory agencies to the Senate Banking Committee, these are instruments whose primary purpose is to transfer price risks associated with fluctuations in asset values rather than to borrow and lend funds. Most of the debate concerns over-the-counter derivatives, which are tailored to the needs of the purchaser, versus the off-the-shelf variety obtained through financial exchanges. In general, these derivatives are contracts obligating the parties to make payments to each other, or one to the other, under specified circumstances. (Derivatives can be more broadly defined to include such derived securities as collateralized mortgage obligations and other structured financings such as asset-backed securities. Such instruments are not part of the general debate on derivatives.) BANKS' ROLE GROWS. Among banks, the interest-rate swap market has long been dominated by a handful of large institutions serving as dealers. More recently, some regional institutions have begun dealing, where before they were strictly users of swaps (endusers in the lingo of derivatives). A larger group of banks--as well as numerous nonbank corporations--use the wide range of plain and fancy derivatives as hedging devices. The many financial institutions that aren't players to any degree, and that watch the current debate from afar, may wonder, What is all the fuss about? Here's what it's all about. DERIVATIVES CAST A GIANT SHADOW An essential concept to understand before you can fathom the debate over derivatives is notionals. Consider a very basic interest-rate swap where one party wishes to pay a fixed rate and to receive a floating rate and the other party wishes to receive fixed and pay floating. …" @default.
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• W38858796 date "1993-12-01" @default.
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• W38858796 title "Derivatives under Scrutiny" @default.
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