Unlikely to be a Major Ccause for Bank Failures



The Wharton School

The Wharton Financial Institutions Center (part of the Wharton School) published "Risks in Derivatives Markets' which dismissed the potential for systemic failure caused by derivatives and blamed the loses by companies due to derivatives trading on the companies financial officers not acting in the interests of their company.

"While these concerns are valid, our previous analysis suggests that derivatives are unlikely to be a major cause for bank failures. In neither their end user nor their market maker capacities do banks face unusually large risks in derivatives markets. Just like other firms, banks that use derivatives to hedge their exposures have lower default risk on their derivatives than they have on their other fixed obligations. In the case of banks, these obligations include debt and deposits. Moreover, this risk management with derivatives makes the bank less likely to default on any of its obligations." [ 1 ]

"The derivatives losses incurred by firms like Procter & Gamble, Gibson Greetings, and Barings Bank gained notoriety because of their size-not because there was serious concern that the companies would default on the contracts. Nevertheless, these losses share a disturbing pattern of inappropriate incentives and ineffective controls within the firms. In many instances, the magnitudes of the derivative losses and hence the underlying derivative positions came as surprises to senior management and shareholders. This suggests that employees with the authority to take such derivatives positions were acting outside their authorized scope and were not acting in the best interests of the firms' owners." [ 2 ]

The Bank of International settlements underestimates the size of the global OTC derivatives market by US$7 trillion (million million).


Brooksley E. Born the new chairperson of the Commodity Futures Trading Commission (CFTC) tried to require that derivatives be traded under the control of the CFTC. She was fiecely opposed by Alan Greenspan (Chairman of the Federal Reserve), Robert Rubin (Secretary of the Treasury 1995-1999) and Arthur Levitt Jr. (Chairman of the Securities and Exchange Commision). Later she would be opposed by Lawrence Summers (Secretary of the Treasury 1999-2001)

[ 1 ] Risks in Derivatives Markets. Ludger Hentschel and Clifford W. Smith, Jr. November 20, 1995 pg.18-19

[ 2 ] Risks in Derivatives Markets. Ludger Hentschel and Clifford W. Smith, Jr. November 20, 1995 pg.19

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